00:00What are the implications for the equity space when you're seeing yields rise so high?
00:06So when you think about equities, obviously there are two components.
00:09There's earnings growth, where the revisions are generally strong, but particularly in
00:13upstream sectors like AI-related capex.
00:15And then there's the discount rate, which is where those yields come in.
00:19And yes, nominal yields are backing up, but we tend to be more interested in looking at
00:23real yields, because equities are a real asset class, and real yields are also rising.
00:27So 10-year tips yields are about 2.15.
00:30It's nothing to be too alarmed about.
00:32The recent peak from 2023 was higher, but it will probably push valuations down a little
00:38bit from current levels.
00:39But the underlying earnings growth, particularly here in Japan, is strong enough that it means
00:44that we have upside to our targets.
00:46So our topics target, for example, 4,300.
00:49We think that's eminently achievable over the next 12 months.
00:52I was going to say, especially here in Japan, when we're talking about real yields, that
00:56story that Japan is back, which sort of got started around the time this Morgan Stanley
01:02MUFG event started, about two, three years back.
01:06Is that still intact with the Iran war going, with the oil shock, given how dependent Japan
01:12is on the Middle East?
01:13Yeah, it actually dates back probably to the middle of the last decade, when the famous
01:19three arrows of Abenomics really began to work together.
01:22So monetary, fiscal policy, and I guess sort of structural reform, particularly corporate
01:26governance reform for equities.
01:28But there's been bumps along the way, notably during Covid, which was an enormous shock for
01:32the global economy.
01:34But Japan has tended to navigate it quite well.
01:37And the basic policy parameters are intact.
01:40And I would emphasize that Japan's fiscal position is far stronger than many people understand
01:45it to be.
01:46There's declining gross and net debt to GDP ratio.
01:48And the underlying fiscal position is about a 1 to 2 percent of GDP budget deficit.
01:54It's actually the best in the G7.
01:56So I don't think there's particular concern from a Japan perspective about the rise in yields.
02:01But I would point out that JGB 10-year yields are still 40 basis points below German 10-year
02:07yields in the eurozone.
02:09So Japan is still able to fund itself in its own currency at very low yields.
02:15We've been talking about inflation being above that BOJ 2 percent target for the last four
02:19years.
02:19And then you have the oil shock and you have the supply chain disruptions.
02:23At what point does it become painful for not only households, but for businesses, and it
02:29gets reflected on the earnings potential?
02:31Yes.
02:32It's certainly the case that if you say look at the consumer sectors and some of the downstream
02:36industries, there is pressure on earnings.
02:39There are downward earnings revisions.
02:40But Japan has many points of strength in semiconductors, IT, capital goods, defense-related spending,
02:48also energy-related spending.
02:50In aggregate, it has a very positive breadth of revisions.
02:54In fact, it's the most positive.
02:55It's number one globally, S&P is number two, and the eurozone, in fact, is the one with
03:01downward revisions in aggregate.
03:03When it comes to that tech-strength semiconductor-related strength, of course, we can't forget South
03:08Korea.
03:09Yes.
03:10Incredible rally, though.
03:11I mean, at one point, we surpassed 8,000.
03:13Where do you see that market going?
03:15So we've set across our coverage very wide bear-to-bull target ranges going forward.
03:21So that certainly applies for COSPI.
03:24So 6,000 is the bear, 10,000 is the bull.
03:28And we can trade within that range as these global forces buffet the markets.
03:33Korea, for example, is a large oil importer.
03:36But like Japan, it has a very high degree of sensitivity to some of these upstream capex
03:41beneficiaries, and particularly the semiconductor and memory area.
03:44And on that side of things, the earnings revisions continue to be very strong, and my coverage
03:49colleagues, the coverage is led by my colleague Sean Kim, are very constructive.
03:54Yeah.
03:54I mean, I think it was your colleague Sean Kim who talked about South Korea going down
03:58a different memory lane.
04:00So perhaps you're considering more of a super cycle when it comes to the semiconductor boom that
04:06we're seeing in South Korea that can potentially keep the markets supported.
04:11Yeah.
04:11Yes, that's right.
04:12So memory, of course, historically is a notoriously cyclical area, and it is a sort of short cycle
04:18capital good historically.
04:19But what you're now seeing is that the use of memory in inference in AI is so significant
04:24and the capital spending is so large and structural that you're moving towards long-term contracts.
04:29So the hyperscalers are starting to sign long-term contracts with the memory firms, which means
04:35that they should trade on a higher multiple.
04:36So you've got higher trend earnings growth and probably a higher multiple as well.
04:41These kinds of things don't come along very often in investment.
04:44I covered the miners, for example, during the China construction boom when they moved into
04:48a mining super cycle at the early part of this century, 2003, 2004.
04:54I was trying to remember.
04:55What was that?
04:56That was 20 years ago.
04:58But the super cycles, by their definition, don't come around very often.
05:01But this is one.
05:02Are we going to see more markets' divergence between the haves and have-nots?
05:08Northeast Asia versus, say, India's underperformance, Indonesia, the Philippines?
05:13Yes.
05:14So we are starting to see the energy shock really pressurizing some macro balance in parts of
05:19South Asia.
05:20And from an equity perspective, they have a skew that's very towards the consumer services
05:26and downstream industries.
05:27So that pattern of skewedness in earnings revisions is tending to act to the detriment of South
05:33Asia markets, generally speaking.
05:33Especially without that exposure so much to the tech and semiconductor super cycle?
05:39Yes.
05:39I mean, even if you say look at a market like Australia, which clearly is a developed market,
05:43you're seeing the same thing.
05:45So areas that are of strength include sort of copper, upstream energy, but some of the financials
05:51and the consumer in Australia is starting to get into a more difficult situation.
05:55China?
05:56So China is interesting because China is very resilient in terms of the way the dual circulation
06:01economy has worked.
06:02It's essentially able to continue to function through the energy shock because it just has
06:07so many different sources of energy supply and it can change the energy mix.
06:12It's actually been helping the rest of Asia, particularly around reducing its gas and oil imports.
06:18But the issue for the China indices is, again, you have e-commerce and consumer facing mega
06:26caps that are arguably, and I say arguably because the debate rages, going to be somewhat disrupted
06:31by AI.
06:32They're obviously investing in AI, but they're a threat from the Chinese indigenous low cost
06:37LLMs.
06:38And you just, you don't have yet, you may eventually have, but you don't have yet the
06:43upstream chip sector well represented in the, certainly the offshore indices.
06:48China is quite exposed to some of the hardware.
06:51Yes, that's right.
06:52And that's why my colleague Laura Wang absolutely prefers A shares and industrial, domestic, semi-localization
06:59and tech in A shares to the broad offshore indices.
07:04Is there sort of the same level of upside potential for Chinese equity surrounding tech when we
07:09continue to see the decoupling with the U.S. and Western markets?
07:13Yes, but it gets very stock specific.
07:15It's not really an index story.
07:18And we have to remember that the underlying deflationary forces for the consumer are still there,
07:24that the wealth effect from the property unwind is still there.
07:27And so we had some quite disappointing retail sales numbers in China quite recently, which
07:31show that that two-speed China economy is continuing to be with us.
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