Commodities continue to outperform bonds with a resilient US economy forcing bond investors to price out near-term rate cuts and tight oil supply driving energy prices higher.
Major central banks may be at or close to peak rates but we doubt interest rates can come down without recessions. Therefore, it wouldn’t be a surprise to see commodities outperformance continue for now.
In this environment of high for longer interest rates, Japanese equities can act as an ‘anti-bond’. Japanese equities can do well in currency hedged terms because the yen tends to fall as global bond yields rise, boosting the overseas profits of Japanese companies. Yen weakness could persist while the US economy remains firm, even in anticipation of an exit from negative Bank of Japan (BoJ) rates next year.
Japanese equities have outperformed especially strongly against emerging market equities (chart 1), benefitting from better corporate governance and a relatively strong earnings outlook (chart 2) with emerging market and Asian counterparts hampered by China growth worries.
Looking further ahead, recession risks linger for major developed economies, and it could be that the lags of monetary policy are just much longer than usual given the more widespread use of fixed rate financing. We are aware that Japan is likely to underperform if recessions force a global rate cutting cycle, so we are monitoring business cycle developments carefully.
Chart 1: Japan vs emerging markets and Japanese yen
Source: LSEG Datastream as at 15/09/2023
Chart 2: Royal London Asset Management Relative Earnings Revisions indices – Japan earnings picture looks strong
Source: RLAM, Refinitiv DataStream. RLAM Relative Earnings Revisions indices are calculated using numbers of upgrades and downgrades of analysts' EPS estimates for each region
Global equities ended the week higher in choppy trading. Japanese stocks led regionally for the fourth consecutive week, followed by the UK. US stocks underperformed as technology stocks fell. Gilt yields fell on weaker UK economic data, despite yields generally rising globally. US 10-year yield neared cycle highs at 4.33%, while Japanese 10-year yield rose above 0.70% on BoJ Governor Ueda’s comments around a possible exit from negative rates. Eurozone bonds underperformed despite a dovish hike by the European Central Bank (ECB). Brent continued to push higher, reaching $94.5 per barrel, as Organization of the Petroleum Exporting Countries and the IEA both warned of significant supply deficits for the fourth quarter.
China hard data perked up, but there was disappointment across UK activity data releases. Meanwhile, UK pay growth remained strong (and a Bank of England hike this week is widely expected). US Consumer Price Index data surprised on the upside (though a US Federal Reserve pause is still expected this week). The ECB hiked 25 basis points to ‘reinforce progress towards its target.’ They kept the door open to another rise, but also reinforced expectations that this could be the last hike.
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