{"id":90754,"date":"2020-04-17T01:38:52","date_gmt":"2020-04-16T23:38:52","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/fast-moving-valuation-case-prompts-japan-downgrade\/"},"modified":"2020-04-30T20:17:39","modified_gmt":"2020-04-30T18:17:39","slug":"fast-moving-valuation-case-prompts-japan-downgrade","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/fast-moving-valuation-case-prompts-japan-downgrade\/","title":{"rendered":"Fast-moving valuation case prompts Japan downgrade"},"content":{"rendered":"

But what happens when this \u201cmoney\u201d dries up? That is essentially what we have seen in the
\npast few weeks \u2013 firms across the world, both big and small, have seen a liquidity crunch as
\nspending by consumers and businesses has essentially ground to a sudden halt. Add to that the
\ndifficulty in predicting how countries will continue to be affected by and recover from Covid-19,
\nand we have the ingredients for forecasting uncertainty. Valuing companies just became a whole
\nlot harder.<\/p>\n

In the absence of a clear trajectory around corporate cash flows and earnings, with many
\ncompanies themselves withdrawing future guidance, using some of the more conventional
\nvaluation techniques such as price-to-earnings is challenging given the unknown denominator.
\nSo, during recent bouts of market volatility, we have found book value analysis a helpful tool in
\nthe equity valuation toolkit, given that it tends to be more static in nature. <\/p>\n

Book value analysis essentially seeks to determine the realisable value of a company\u2019s assets in
\nthe event of liquidation, ie, what is left for equity holders according to the company\u2019s balance
\nsheet. A 1x price-to-book value would imply that the market is only willing to pay the equivalent
\nof book value for a company, or in other words does not believe that the company can deliver
\nsignificant positive growth from its assets.<\/p>\n

We applied this valuation lens to equity markets in early March, seeking to determine levels at
\nwhich different regions would reach attractive enough levels for us to deploy our risk budget. As
\nmarkets tracked downwards, Japan increasingly stood out with prices falling through 1x book
\nvalues in mid-March \u2013 very close to the lows of the past 20 or more years (Figure 1). History tells
\nus that prospective 12-month returns from these levels are asymmetric to the upside (Figure 2),
\nhence we added to our Japanese equity exposure.
\n\"-763.jpg\"<\/a>
\nHowever, with decade-high volatility, key valuation levels are being triggered more frequently
\nand, with the fast-moving economic and human response to Covid-19, fundamentals are
\nchanging quickly too. <\/p>\n

Japan\u2019s outperformance<\/strong><\/p>\n

In the case of Japan, the equity market managed to outperform global equities by a stellar 13%
\nover the second half of March, making relative valuations less attractive within a short space of
\ntime. Although still supported by the long-term structural improvement story of better corporate
\ngovernance, Japan is a strongly cyclical and operationally leveraged market that is highly
\nexposed to \u201csudden stops\u201d in global activity; room for stimulus is also judged to be more
\nconstrained than elsewhere. And, unlike other regions, savage falls in earnings expectations had
\nyet to come as of a week ago \u2013 unrealistic by our judgment.<\/p>\n

In keeping with our investment process, where either changing valuations and\/or fundamentals
\ncan prompt a change in view, we have downgraded Japan to a neutral from favour, reflecting
\nthose fuller relative valuations and softer fundamentals in the current global setting. Although we
\nretain an overall preference for equities (alongside higher-grade credit), today it feels prudent to
\nconcentrate risk in less cyclical areas better placed to weather the storm.<\/p>\n

In these abnormal times, money does not make the world go round \u2013 healthcare workers do. But
\nmarkets remain open and dislocations will continue to emerge as the markets attempt to price
\nthe effects of this unprecedented and sudden stop to the normal flow of money.