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Our views 29 October 2024

ClockWise: From one political wall of worry to another

3 min read

Our measure of equity sentiment reached oversold levels last week, despite global equity markets hovering around all-time highs.

This is due to equity market volatility remaining high and retail investors starting to turn more bearish amid heightened geopolitical risk and upcoming elections. We remain positive on equities into the US elections given supportive fundamentals, but we wouldn’t rule out weakness in the short run, as polls still suggest a tight US Presidential race despite betting markets pointing towards the re-election of President Trump.

The US is not the only country presenting election risk. On Sunday, we had a Lower House election in Japan, which resulted in the ruling Liberal Democratic Party (LDP) and its junior partner Komeito failing to retain a majority for the first time since 2009. They now have a 30-day window to form a new government. As it stands, the fractured nature of the opposition means that the LDP is likely to be weaker but stay in power. The Japanese Prime Minister Ishiba – who was only sworn in as Prime Minister on 1st October – has stated that he does not plan to resign and intends to govern as a minority government rather than forming a new coalition. With the Upper House election coming up next year, things can change quickly.

Japan therefore enters a period of political uncertainty, and we expect the Bank of Japan (BoJ) not to raise rates in the near term.

With US yields rising generally since September as US recession risk receded, this has resulted in widening interest rate differentials between the US and Japan and caused the Japanese yen to weaken (chart 1).

Chart 1: US 2-year yield less Japan 2-year yield vs Japanese yen

Chart 1 shows US 2-year yield less Japan 2-year yield vs Japanese yen

As mentioned in the past, Japanese equities normally 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 if the US economy remains relatively strong with the BoJ not in a hurry to raise rates during political turmoil. If Trump is re-elected, that could also push US bond yields higher, with his policy platform seen as inflationary by many.

Unusually however, Japanese equity markets have not outperformed in local currency terms recently despite the weaker yen (chart 2). This could be partly explained by investors shying away after the ‘blow up of the yen carry trade’ in August, which saw a 12% one-day sell-off in Japanese equities.

Chart 2: Japanese equities relative to emerging markets vs Japanese yen

Chart 2 shows Japanese equities relative to emerging markets vs Japanese yen

We had shifted to a neutral view on Japanese equities before Sunday’s election, but looser monetary and fiscal policy could result in a more positive outlook once the political picture becomes clearer. Meanwhile the upcoming UK budget and US election keep potential policy change on the radar outside of Japan too.

 

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.