Let's talk about what I like right now in the investing landscape.
I like Japanese stocks. The major averages have broken a 25-year downward trend-line. Small-caps have been outperforming, so this transcends the weak yen stimulus. Female participation rates are on a secular uptrend and prior taboos, such as importation of foreign labour, have been broken.
Next comes the nationalistic phase of Shinzo Abe's legacy that is rewriting the constitution and embarking on a more rigorous military policy. Political stability is intact, a rarity around the world. And the Nikkei 225 and Topix also are rare benchmarks trading at multiples at or below their historical norms. So far in this bull market, 80 per cent of the total return has come from pure earnings per share (EPS) growth and the remainder via dividend yield – now matching the United States – and higher payouts. There has been no P/E expansion at all – that comes next. In the United States (on a comparable positive EPS-only basis), 20 per cent of the total return has come via earnings, 60 per cent from P/E multiple expansion and 20 per cent from dividends. You choose. And the Japanese market is underowned globally and among the locals – there is more retail money sitting in zero-per-cent bank deposits than in Japanese equities.
I like global defence stocks. Not just because of the changes in Japan, but because of what Japan is responding to … the escalating threat from North Korea as well as the move by China's Communist Party to inscribe President Xi Jinping's new "guide to action," which most certainly will involve attempts at greater dominance in Southeast Asia.
And insofar as a primary goal involves China moving "closer to centre stage" in the world, this means greater efforts to ensure that the One Belt One Road strategy (building infrastructure links between the East and West) will be a success. This, in turn, should be beneficial for basic material prices and global shippers.
I'm bullish on various measures of volatility that will confront a lot of change in coming months and quarters. A shift in global monetary policies for one – quantitative tightening (QT) in the United States; rate hikes in both the United States and Britain (for the latter, 90 per cent priced in now for year-end given inflation well above target at 3 per cent); tapering by the ECB; a new ECB president to be chosen, not to mention someone new at the helm at the Fed as well. In addition, we have rising populism in Europe, with implications for the Italian election; continuing tensions in Spain; the virtual breakdown of the Brexit talks; the likely abrogation of the North American free-trade agreement, which could tip the U.S. economy into a recession with or without tax reform; heightened odds that the Democrats take the U.S. House a year from now. Did I miss anything?
I like high-quality government bonds. Pundits think QT in the United States and the taper in the euro area are negatives. But in fact, because these central bank reversals are more likely to dampen the "animal spirits" that were whetted during this age of monetary largesse, we may well find that "buy the dips" was a reference to U.S. Treasuries, not equities. Be that as it may, we could well see the 10-year T-note gravitate back to the high end of the 2.3-per-cent to 2.6-per-cent range, given the "reflation" psychology in the market and, as we had mentioned in recent weeks, the massive net long position in the futures and options pits on the Chicago Board of Trade that has yet to be fully unwound.
But this will come back to bite because 42 of those epic 54 records the Dow has turned in this year came when the 10-year yield was south of 2.4 per cent. I also see core inflation coming down further, based on base effects, the rebound in the U.S. dollar and a sustained weakening in rents – as the supply aftershocks linger following this cycle's construction boom. Apartments are growing so affordable that a Freddie Mac survey found that 76 per cent of renters now believe renting is more affordable than owning, up from 65 per cent a year ago.
I also like the energy market. We are getting some really effective guidance from OPEC on the output cut extensions. U.S. storage data are in decline and the API just showed a 5.8-million-barrel weekly slide in gasoline stocks and a 4.9-million-barrel decline in distillate inventories. The technical condition in the crude market has improved markedly and a geopolitical risk premium is starting to get embedded from two sources – uncertainty over Iranian exports and the escalating tension building in Iraq following this recent Kurdish vote on independence.
The Canadian oil-producer stocks have quite a bit of catching up to do if/when West Texas intermediate settles into a mid-$50 (U.S.) to high-$50-dollar-a-barrel range. And this is not just about improving supply-demand fundamentals in the crude oil market but in natural gas as well. And the weather is going to play a key role on the demand side, which will deplete underground gas inventories in that key November-April period. Note that these stockpiles, as per the U.S. Energy Information Administration, stand at 3.646 trillion cubic feet or 4.7 per cent below year-ago levels.
Well, in the name of being consistent, if Mr. Xi can continue to ensure stable growth in China (despite the massive debts at the state-owned enterprises, which have been the bedrock for China's economy) – that also means stemming capital outflows – and if the oil price hangs in, then the outlook for emerging markets will also be rather constructive. India, as an aside, just took some major steps in its budget to spend $32-billion in recapitalizing its debt-laden state-controlled banks (strained by a rising tide of corporate loan defaults).
To be clear, while I am less bullish on Europe than I was before (and correspondingly more positive on Japan), I am still constructive over all. I am impressed with French President Emmanuel Macron, who is forging ahead in parliament to scrap the wealth levy and, in the process, cutting tax rates on capital gains, dividends and interest by 70 per cent to a flat 30-per-cent rate. This is a big departure from the recent past, when François Hollande chose to boost taxes on the highest income earners. Mr. Macron is definitely pro-business and pro-deregulation and is getting things done far faster than is the case in the United States right now.
To read Mr. Rosenberg's views on where NOT to put your money right now, click here.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave. To see his thoughts on where not to put your money, please visit tgam.ca/rosenberg.