Inflation to determine equity markets

Market Development: On the first trading day of 2022, the Japanese market surged significantly, in line with Wall Street. On 5th January, the minutes of the December 2021 US FOMC meeting were published, which suggested earlier than expected tightening in the US.

Fund Commentary
17 Feb 2022

Market Development: On the first trading day of 2022, the Japanese market surged significantly, in line with Wall Street. On 5th January, the minutes of the December 2021 US FOMC meeting were published, which suggested earlier than expected tightening in the US.

The US long-term interest rate rose, causing both the US and Japanese markets to decline. Growth stocks were sold off with the Nikkei 225 Index declining significantly more than TOPIX, as high-priced names form the core of the Nikkei 225.

In mid-January, overvalued stocks continued to decline and the renewed buying of value stocks supported the market. That said, the spread of the Omicron variant and tension between Europe, the US and Russia over the Ukraine crisis caused concern and pulled back the market.

In late January, the Japanese market pulled back further on the back of Yen appreciation and the rise in interest rates in both the US and Japan, as the FRB made Hawkish comments following the FOMC meeting on the 26th of January. Concerns over inflation, driven by rising commodity prices, also affected the market.

In January, the TOPIX closed the month at 1,895.9 (down 4.8% MoM), and the Nikkei 225 at 27,002.0 (down 6.2% MoM). 21 out of 33 sectors fell. The top five performers were Mining, Insurance, Non-Ferrous Metals, Banks and Pulp & Paper. The bottom five performers were Electrical Appliances, Services, Precision Instruments, Metal Products and Machinery.

The 10-year JGB yield opened at 0.07 and leapt up after 5th January, when the FOMC’s minutes were released. Although the BOJ’s Mr Kuroda denied an early change in monetary policy, the JGB’s interest rate kept rising, owing to Mr Powell’s press conference following the FOMC meeting on 26th. On 31st January, the 10-year JGB yield hit over 0.185 for the first time in 6 years and ended the month at 0.178.

The JPY against the USD began at 115.08 and temporarily hit 116.35 on 4th January, after the Dollar appreciation accelerated on the back of the rising US interest rate. Amid the increasing number of new COVID cases and geopolitical risk surrounding the Ukraine crisis, Yen buying predominated and at one point hit below 113.50.

That said, following Mr Powell’s hawkish remarks at the post-FOMC meeting on 26th, US dollar purchasing accelerated and the JPY ended the month at 115.11. The Crude Oil price started at 75.21, and due to geopolitical risk, continued to rise, ending the month at 88.15.

Outlook

There are three major issues having a large impact on the global markets. The first is a new COVID variant – Omicron. The US and some European countries have already experienced its peak of infections, and have begun to relax restrictions on economic activities. Even in Japan, the new infections appear to have peaked, as the number of new infections on 12th February in Tokyo showed an 8.6% decline with a 16,350 weekly average, the first WoW decline since 8th December 2021.

It has been reported that Omicron is less serious than the Delta variant and vaccinations are increasing rapidly. We believe the worst stage is over, the questions are: how quickly; or by what process will the Japanese government begin to lift restrictions. We hope both industry and citizens will be able to return to normal activities within a couple of months.

The second issue is the Ukraine crisis. Nobody knows what will happen in the future. President Putin is a clever person, he should know that nobody can win through military action. US President Biden, along with many European leaders is earnestly making diplomatic negotiations with Russia. We hope and believe that Mr Putin will find a solution to avoid military conflict, as Western allies look to be firmly united.

The third factor is inflation. The Consumer Price Index (CPI) in the US rose 7.5% YoY in January 2022, the highest YoY rise since 1982, putting pressure on the Fed to act more aggressively. The core CPI (excluding foods and energy) stood at a 6.0% increase YoY.

The Fed is expected to end tapering at the next FOMC meeting, together with a hike of the federal fund rate by 0.25% or 0.50%. Within a couple of months of the meeting, QT (quantitative tightening) may start to combat inflation. This being said, excess savings accumulated during the pandemic should continue to spill over to consumption, with labour shortages continuing as infrastructure demands increase.

Although the Fed’s target core CPI is 2% p.a., we expect the core CPI may remain above 3% over the next couple of years. In our view, the 10-year bond yield in the US should rise to over 3%. The problem is that it is unclear how fast or how long the Fed will continue to increase monetary tightening. One thing is clear – the market has changed its characteristics and will continue to adjust its way towards a new paradigm for the medium term.

We expect to see a dramatic change in market leaders, movement from growth to value and from IT to Infrastructure. Relatively, we believe the Japanese market should enjoy the best performance among the major markets with cheap valuations and high weighting in economically sensitive value stocks.

Portfolio Development

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese Yen basis as of 31st January 2022 increased 1.3% compared with that of 30th December 2021, whilst the TOPIX TR Index declined 4.8% during the same period. The large outperformance of the Fund against the index was due to the combination of being overweight to economically sensitive sectors such as Resources, Banks and Marine Transportation, and underweight to Electricals, Services and Precision Instruments. The Fund added one new name (Tokyo Steel) to the portfolio with one stock (Astellas Pharma) sold out.

The Fund continues to be overweight to economically sensitive sectors with cheap valuations such as Trading Companies, Marine Transportation, Iron & Steel and Banking, while defensive sectors such as Foods, Pharmaceuticals, Retail and Utilities continue to be avoided. The Fund takes a very cautious stance towards IT-related sectors.

As always, we invite investors and prospective investors, to contact us should they wish to understand our views on the current situation and the positions held in the portfolio. Please do not hesitate to contact us for further information.

Adam TurbervilleAdam Turberville
Director
+44 1481 742380
a.turberville@ericsturdza.com

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The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Fund as of 16/02/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.