Global fund managers are the most negative they have been on Japanese equities for six-and-half-years amid global trade uncertainties and domestic market weakness, and against a hugely bearish backdrop.

That is according to Bank of America Merrill Lynch’s (BAML) monthly survey of fund managers, conducted between August 2 and 8.*

A net –9% of fund managers (down further from -4% last month) said they were overweight Japanese stocks, found the poll, citing the percentage who were overweight minus the percentage underweight.

This comes with the re-intensification of the US-China trade war, which was considered the biggest tail risk by investors, the survey said.

“Against this backdrop, investors are again degrading their outlook for growth and corporate profits, and expect yields to fall,” it added. “Though still a minority, more investors think the global economy will experience a recession over the next 12 months.”

Earlier this month President Donald Trump had announced a new round of 10% tariffs on $300 billion worth of Chinese imports.

However, yesterday (August 13) the US Trade Representative office announced it would delay new tariffs on certain consumer items until December 15 and remove other products from the new China tariff list altogether. Markets rallied on the news, as concerns eased.

LINGERING PROBLEMS

This could provide a little respite for Japanese equities, but other challenges remain.

Despite a better than expected preliminary second-quarter GDP growth of 0.4% quarter-on-quarter, UOB maintains a cautious stance on Japan’s 2019 growth outlook, wrote senior economist Alvin Liew in a note yesterday.

The Singaporean bank sees Japan still facing significant challenges on two fronts: global trade uncertainties and domestic market weakness in the face of another sales tax hike.

There’s been weakness in exports in the last two quarters that is expected to be exacerbated by both US-led trade uncertainties and the souring trade relations between Japan and South Korea, Liew added.

The latter have come as a result of a deepening dispute between Tokyo and Seoul over wartime reparation. Korean state institutions are even reportedly under pressure to ditch investments in Japanese companies with links to Japan’s wartime slave labour.

In respect of the domestic economy, Prime Minister Shinzo Abe remains on track to raise the consumption tax to 10% from 8% in Oct 2019, noted Liew. UOB takes believes the hike will probably cause the collapse of private spending after the fourth quarter of 2019, driving Japan into a recession in 2020.

MOST UNDERVALUED

All this being said, a net 28% of equity investors think Japan is undervalued, according to the BAML survey (see chart below). That makes it currently the most undervalued country or region this month and bestows on it a mantle that global emerging markets had held for around six years.

JAPAN: THE MOST UNDERVALUED COUNTRY / REGION
(Click for full view)

Accordingly, a net 1% of investors say they want to overweight Japan over the next 12 months, a rebound from -10% in July.

“However, as the issue is more global and Japan lacks policy ammunitions, we think undervaluation alone is unlikely to attract investor interest,” BAML said in its note.

“We have seen corporate earnings lose steam in US-China trade war crossfire. On top of that, we think one key factor is global and domestic fiscal policy as investors see global fiscal policy becoming increasingly restrictive.”

GLOBAL CAUTION

Sentiment is heavily bearish from a global perspective too, with caution the watchword.

Fund managers are the most bullish they’ve been on bonds since November 2008, according to the survey. Moreover, 34% of respondents believe a recession is likely in the next 12 months – the highest recession probability since October 2011 (see chart below).

PERCEIVED LIKELIHOOD OF RECESSION IN THE NEXT 12 MONTHS
(Click for full view)

On top of that, seven in 10 investors say the 10-year US Treasury will not trade below 1% in the next 12 to 18 months, and long US Treasuries remain top of the list of the most crowded trades identified by fund managers.

* BAML's August global fund manager survey (FMS) polled 224 panelists with $553 billion in AUM; 171 participants with $455 billion in AUM responded to the global FMS questions and 115 participants with $211 billion in AUM responded to the regional FMS questions.