Asia ex-Japan Strategy - Markets Proving to Be Both Rational and Resilient - Citigroup

YTD, there has been no breakdown in factor returns or abnormal activity — Market returns post the recovery in earnings have been exceedingly similar in this cycle, as in all prior cycles since 1975. Factors that drive returns have also been similar. EPS revisions worked well last year, as they always do in year 2. Year 3 is one in which momentum rears its head; it is doing so again. Factor returns for value, growth, risk or momentum show no signs of distress of panic.

Valuations at average and with rising liquidity — Sure, markets are no longer cheap. They never are by year 3 of a cycle. Markets are cheap at the start of the cycle and then get more expensive. Even if investors want to be cautious and use average ROE as a valuation (we are currently above average), the “mid”-cycle P/E would be at its 20-year average. Asian profits are beyond their prior peak but valuations are not. Excess liquidity in Asia-ex continues to improve.

Asia-ex vs. Japan now most expensive on P/BV — Japan is now trading at a 50% discount to Asia-ex on P/BV, its cheapest relative level in 35 years. Earlier, the discount made sense due to Japan’s much weaker ROEs, but since 2003 its ROEs have recovered and the de-rating has continued. For decades Japan was the funding market for a long Asia-ex stance. Given where relative value now lies, Asia-ex should no longer take the old status quo for granted.