Faber: Japanese stocks will outperform as US margins deteriorate

Here’s the latest from Bloomberg Television, Marc Faber, the publisher of the Gloom, Boom and Doom Report, thinks that Japanese equities are going to outperform this year. Why? For the same reasons I have been saying that a more defensive posture is warranted: "earnings may begin to disappoint" and "corporate profit margins could deteriorate."

At this point in the business cycle I don’t expect mass deleveraging. I expect some mild – or even robust – releveraging. Moreover, in the US, the federal government deficit is still high and households are releveraging. That is supportive of profit margins. And this should continue through the election in November 2012. What I see in the meantime is mounting negative earnings surprises. We need to watch the policy response for pointers on where asset markets are headed. If we get a muted response, that would be negative for shares and other risk assets.

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What I am saying here is not that earnings will fall per se but that the growth in earnings has already stalled and will therefore disappoint. And because I believe we are still in a secular bear market, that means you have to rotate into more defensive strategies and/or increase weight in more defensive sectors/asset classes for fear that the earnings growth decline becomes something more severe by 2013. Secular bears are killers of capital when markets turn down violently. Faber is basically saying that he agrees with the margin compression argument I have been making these past few months. But, as he is an international investor, his advice is to diversify into different country risk. Marc says Japan will outperform.

Take a look.

Source: Bloomberg Television

Partial transcript below

Faber on whether he’s finding more shorts in the equity market:

"In a money-printing environment I’m reluctant to short. But say whereas I recommended investors to increase their positions last October, November, December, now I think that if people are overweight in equities they should reduce positions somewhat…maybe cash. The U.S. dollar is desirable at the present time. And we have to say one thing. The market consists of thousands of stocks and the market consists of many different stock markets globally. The S&P has done exceptionally well relative to, say, emerging economy stock markets, most of which are still lower than they were in 2011. So, if you look at the advance-decline line of all the share markets in the world, then it is definitely being deteriorating. And I happen to believe that money printing will continue and I would probably buy financial shares and I believe that the Japanese market may outperform all the other markets against all expectations in 2012."

On saying that earnings will deteriorate and profit margins will shrink:

"First, I think there are some cost pressures creeping in terms of rising raw material costs, especially energy, and the problem with, say, a QE3 would be that you are doing it in an environment of very elevated oil prices. So, maybe the energy prices would go up more and squeeze the margins of some corporations. And certainly squeeze the consumer. And my sense is that the economy has bottomed out but is far from robust because the typical household is being squeezed by higher cost of living increases. There are various measurements. You can measure the CPI. It is rising by less than 3%. Everywhere I look I see households essentially paying between 5% to 10% more for goods and services than a year ago."

On whether Q2 will be as strong as Q1 for investors:

"I think that if you look back at a year ago we made a peak of 1370 on S&P on May 4 and then dropped sharply to 1074 on October 4. Then we recaptured the lows in November and December. Since then, the first quarter has been very powerful and has surprised investors because of its strong performance. And I think now the expectations are very high. The market is no longer oversold the way it was in December. And everybody thinks that the race is on, go along with equities, the hedge funds have positioned themselves on the long side and optimism is high. I would be very careful at this stage."

On why investors should have caution:

"Basically I think that earnings may begin to disappoint. That corporate profit margins could deteriorate. And I think we still have a lot of issues. Don’t forget we have QE1, QE2 and Operation Twist. I think in order to really hold asset prices across the board much more QE3 would have to be gigantic. I’m not ruling out that stocks can continue to go up but I doubt they will go up at the same rate as the first quarter. And if you look at the technical under underpinnings of the market, they have deteriorated. The list of new highs is deteriorating. The short positions are way down. And we have an overbought condition in the market if we measure the number of stocks above the 50-day and 200-day moving average. So, generally I would say maybe April is traditionally still a month of seasonable strength but somewhere in the next six months I think you can buy the whole market much cheaper."

On QE3 having to be "enormous":

"It would have to be very significant to boost all asset prices including homes, stocks, bonds and commodities…Much larger [than QE1 and QE2]."

On why he’s not recommending to buy more gold:

"As you know, I have been very positive about gold and I still accumulate gold every month. But I think that we had an intermediate peak at $1921 on September 6 of last year. Then we dropped sharply to $1,522 an ounce on December 29, 2011. Since then we’ve had a feeble recovery. I think that the correction period is not yet over. I’m not selling my gold because I don’t trust governments and I don’t trust the Federal Reserve, nor would I trust the ECB or other money traders in the world. They are all going to print money. I still recommend to hold gold."

On bad returns for gold in Q1:

"Yes, that’s correct. But the returns have been very good since 1999 and year over year I think gold is still up 12%…I think that gold is in a correction period and we had an intermediate peak on September 6, 2011. And I always advise don’t put all your money into gold because it doesn’t have any cash flow. So you are really dependent on the price appreciation. That is different from owning, say, equities that have a dividend yield of 5%, which I can find in Asia."

  1. David Lazarus says

    There may be more earnings falls than you might expect. Those companies with high exposure to Europe could be affected quite significantly, as Europe slows down. I agree that with Marc faber that shorting is not sensible when central banks are inflating the economy with QE, you could get caught out. Though I am not so sure about Japan. It could do well but remember that Japan is still experiencing power cuts so that would be a constraint on growth there.

  2. Steven Towns says

    Thanks for this post. While most readers are probably most interested in the margins deterioration story, my focus as a value investor and being particularly interested in Japan is on the broad undervaluation of equities that persists. Many will quip that Japan = value trap. At 30,000 feet, sure. Roll up your sleeves, leave EWJ for someone else to trade, and you’ll find some tremendous opportunities. ROE is nowhere as bad as it appears on the surface. Lots of things accepted in the West about Japan at face value, which is a shame, but great for value investing. For more, see details about my recently-published book, Investing in Japan: No market as undervalued and as misunderstood. https://bit.ly/GFaNqj

    1. David Lazarus says

      While I am not so bullish on Japan as Faber, I do see merits of being invested there. I just would not go excessively overweight but active traders could definitely find bargains there.

      1. Steven Towns says

        David, interesting, your mentioning of active traders since that’s how most tend to approach Japan. There’s def merit in a mkt that features such large exporters; i.e. cyclicality. But I’m not so interested in quick trades. I discuss such in my book, which was written more for value approaches but (1) is equally as informative to traders and (2) it’s easy to discern and develop trading strategies. No question that more trading volume would be readily welcomed in Tokyo and Jasdaq. Beside value investors, ideally more pension funds will come around to recognize they are best positioned (patient capital) to take advantage of deep undervaluations. Hopefully I’ll have a shot at conveying all this to them!

        1. David Lazarus says

          My concerns are people trading in markets that they do not understand. Japan is unusual in that companies have lots of shareholdings in suppliers or customers. That changes mindset. The Olympus scandal is a good example.

          I agree with you about buying at cheap valuations. Though if you listen to Wall Street analysts you hear PE of 26 are cheap. Bullshit. PE of 4 is cheap. I remember when UK banks had PE’s in low single digits, and that was not at a crisis. Sometimes high PE are not a sign of health but sickness, and a coming collapse in the share price.

          As for trading volume, you need to think why? Personally I fully expect another substantial drop in share prices and under those circumstances why buy into a rigged market where high frequency traders skim off your profits?

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