Investment in a Minute – Tactical thinking: Embracing Market Volatility

5 min read 14 Mar 24

“When sentiment is this poor, you do not need a lot of good news to drive stocks. The removal of incremental bad news can itself be the catalyst.”

- Michael Dyer, Investment Director, Multi Asset

China: the contrarian perspective

In the realm of contrarian investing, market scepticism often unveils hidden opportunities. While acknowledging that long-run fundamentals can drive markets, we also recognise that short-term market dynamics can offer profitable tactical opportunities driven by investor sentiment.

Despite structural challenges like debt, deflation and aging demographics in China, the key questions remain: ‘’Has, and by how much, the market already priced this in?’’.

To avoid catching a falling knife, we prioritize markets that offer a level of margin of safety through supportive valuations, and evidence of excessive behavioural reactions, such as levels of capitulation or panic selling.  

Notably, the late October 2022 market bottom in China (a point, on hindsight, that turned out to be an excellent buying opportunity) seems to exhibit similar conditions today. 

The recent downturn in Chinese equities in January, triggered more by investor sentiment than fundamental changes, presented an intriguing scenario similar to previous market corrections – the Global Financial Crisis, Euro crisis and the 2015 – 2016 growth slowdown – with valuations on many Chinese equity indices presenting extremely attractive entry points into the market, in our view. 

Despite the post-low rally, pessimism appears to be widespread. While some of this pessimism is partly justified by past corporate earnings, it underscores the market's underestimation of potential earnings recovery. When sentiment is this poor, you do not need a lot of good news to drive stocks. The removal of incremental bad news can itself be the catalyst, as it has proved to be in the rally thus far. 

Japan: a promise of delivery

If China’s narrative revolves around navigating structural challenges with contrarian opportunities; Japan’s story is about capitalising on structural tailwinds amidst growing consensus. The real test for Japan now, is fulfilling its potential for structural reform and inflation adjustments.

Late 2022 to early 2023 presented an attractive entry point into Japanese equity markets, when the TOPIX was trading on 12x earnings and international investors were dismissive of another round of ‘this time it’s different in Japan’ rhetoric. 

The good news is that this time it really does feel different, with the Nikkei 225 finally surpassing the historic highs of December 1989. The promise of a different outcome seems tangible.

Since last year, valuations have richened but remain reasonable, momentum appears behind Japan such that it should reach escape velocity for the Bank of Japan to restore positive rates. 

Additionally, underlying corporate reform is a powerful driver of bottom-up earnings and the more secular bull market in Japanese equities is likely to see continued inflows from international investors long underweight Japan. 

Thus, while Japan may no longer be a contrarian call, the structural case remains intact. 

US: a surprise landing?

It has not just been the Nikkei making new highs, the S&P 500, propelled by the ‘Magnificent 7’ has broken 5000. This recent surge, driven by a select group of high-performing stocks, reflects heightened market optimism. 

Contrary to last year’s forecast of a ‘soft landing’, current market expectations suggest a robust economic performance without the anticipated slowdown. With a ‘no landing’ appearing to be increasingly priced in, in our opinion, it makes treasury bonds more appealing than equities at present. 

The adjustment of 2024 GDP expectations, alongside persistent inflation, also indicates a shift in market dynamics, with equity markets focusing on growth over ‘higher for longer’ interest rates concerns. 

However, the optimism priced into US equity multiples warrants caution, as the narrow leadership of the S&P and high valuations may pose risks of disappointment. 

In the meantime, real yields on treasuries are commensurate with the pre-GFC era and look to offer a decent asymmetry of valuation and diversification properties. 

And finally… the US presidential election cycle has kicked off in earnest with the Super Tuesday primaries. Markets are predicting a 90% chance of a Trump vs Biden rematch. All we would note is a reminder to investors that forecasting election results is notoriously error prone and, even then, markets have a habit of compounding that forecast error by not reacting as one would expect!

By Michael Dyer

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. 

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