Sector rotation in Japan has seen traditionally defensive sectors such as pharmaceuticals and utilit...
Sector rotation in Japan has seen traditionally defensive sectors such as pharmaceuticals and utilities sold down in favour of more cyclical areas such as technology and telecoms.
The move, which has come despite markets remaining relatively flat, is a reflection of forecasts for global growth to reappear next year, according to Denis Clough, Japan fund manager at Schroders.
For utilities, which in the past three weeks has given away much of the gains made since March 2000, investors took the view that valuations could not go higher, adds Simon Donne, Japan fund manager at Threadneedle.
Donne says the recent fate of utilities is illustrated by corrections in the Topix Electrical & Gas Index, which hit highs of 780 points in July. It has since dropped to 650. Threadneedle trimmed its utility holding to half market weight earlier this year, when valuations began to look stretched, says Donne.
Clough, who is underweight utilities but overweight pharmaceuticals, says the fates of the utilities and pharmaceuticals sectors are illustrated by deratings in individual stocks. He says Tokyo Electric Power is down 11% since the end of October, while Takeda, Japan's largest pharmaceutical, is down 7%.
Investors, says Clough, traditionally use the utilities sector as a cash safe haven. In deteriorating market conditions, they tend to make gains against a falling market as investors seek to shelter their assets. Once sentiment has turned, in this case anticipating an upturn in global growth in the first half of 2002, they tend to be sold down.
A cloud also hangs over the sector. Electricity and gas suppliers are able to charge higher prices than comparative global peers, a situation deregulation is likely to change. The other disturbing factor is that the level of yield they are offering has fallen, providing one less reason to hold them. With this in mind, says Clough, the market is favouring cyclical stocks, including technology. He holds selected semi-conductor component makers in his portfolios but is not convinced that many stocks are likely to justify the valuations they are beginning to attract.
Clough says: 'People are anticipating an upturn in global growth. It is realistic to expect an improvement some time next year. The question is when you look at the companies and their profits prospects, which ones will justify their valuations?'
Because of this Clough favours what he terms 'conservative' cyclical stocks with strong balance sheets, cashflow and, in many cases, a domestic focus.
In its shift towards cyclicals Threadneedle has upped its technology and telecoms weightings to just above market weighting.
Both Clough and Donne agree on the long-term demographic support for the pharmaceutical industry and it is on this view that both retain above market weightings in this area.
Donne sees potential for merger and acquisition activity in pharmaceuticals, which ' unusually in the global context ' has seen little rationalisation.
He believes there could be larger companies created from the large number of middle order players and there is the possibility that even a UK or US firm break into the Japanese market through acquisition.
Donne also believes Japan pharmaceuticals are attractively valued compared with its global peer group.
Pharmaceuticals good long-term outlook.
Global growth to return next year.
Pharma valuations globally reasonable.
Utilities have suffered sell off.
Deregulation threatens utilities.
Many cyclicals will not justify valuations.
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