by Jeff Weniger, CFA, Head of Equity Strategy & Kevin Flanagan, Head of Fixed Income Strategy, WisdomTree
U.S. stocks just hit an intriguing threshold: the S&P 500’s earnings yield fell to parity with the 10-year Treasury Note yield. The S&P 500’s forward P/E has melted up to 25, leaving its reciprocal, the earnings yield, at 4.0%. Earning yield equivalence with T-Note yields need not spell death to bull markets, but it is an obstacle when we stop to remember that for years the justification for overweighting stocks was the “TINA” trade. That concept said to buy all stocks because “There Is No Alternative” in a negative bond yield world. At 4% across the board in Treasuries, TINA is dead.
Contrast the stocks vs bonds trade-off in the U.S. with the Japanese situation. The TOPIX 500 trades for 16.8x forward earnings, giving Japan an earnings yield of 5.94%. At the same time, 10-year Japanese Government Bonds (JGBs) yield just 1.66%. That puts Japan’s earnings yield 428 basis points higher than what can be clipped in sovereign bonds, make the opportunity appetizing relative to the United States.
Part of the reason behind Japanese stocks’ discount to the U.S. is the profitability gap; the U.S. has a Return on Equity (ROE) of 18.3%, while Japan’s broad market has yet to break above 10% on that measure (though some forecasters believe Japan will get its act together). Japan’s unacceptably low profitability backdrop is one of the top two bearish counterarguments we hear from advisors; the other is the country’s population shrinkage.
Many asset allocators think the profitability story will turn. Last week, UBS’ Chief Investment Office put out a research note titled, “Political Clarity Can Unlock More Gains for Japanese Equities.” In it, the investment team states that “ongoing structural reforms, including unwinding cross-shareholdings, accelerating share buybacks, and business portfolio restructuring, are driving improvements in return on equity (ROE) and profit margins.” It goes on to say that the country’s “push for higher return on equity is also prompting companies to focus on efficiency and shareholder returns, supporting the case for a longer-term rerating.”
When UBS strategists cite “political clarity,” that is a reference to the ink drying on Sanae Takaichi becoming the Prime Minister. We believe she will uphold the necessary ballast of Japan’s bull market: Abenomics. That reform program, initially implemented by former PM Shinzo Abe over a decade ago, called for a corporate governance overhaul, a de facto acceptance of yen weakness to gain competitive advantage, and aggressive fiscal stimulus. As the “Takaichi trade” continues to take hold, we were greeted this week with a burst above 50,0000 on the Nikkei 225. That index is up sharply from the sub-32,000 it slinked to in the springtime Tariff Tantrum.
Another case for Japan: it’s not the U.S. That sounds like a bizarre statement, what with U.S. stocks dominating the rest of the world over the last generation. But consider this: because of high expectations in Nvidia, Broadcom, Tesla, Oracle and Eli Lilly specifically, 25.5% of the U.S. stock market’s total valuation is in names that trade for more than 50x reported earnings. In contrast, the TOPIX 500 has 10.9% of its market cap in companies with such multiples.
Intriguingly, the S&P 500 Growth relative to S&P 500 Value series is bumping up against critical resistance. Draw a line from the two major Growth-to-Value transitions, which were March 2000 and November 2021, and the result is a trendline that is being touched right now. For investors who are of the view that that resistance will hold, Japan may be something of a saving grace because of its 12% Tech weight, which is about a third as much as the 33.5% exposure to that sector in the S&P.
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