Wednesday, June 14, 2006

Tokyo Momentum Update

While the Average stock in Japan is down about 16.5% CYTD, and the indices have shed nearer to 20%, little has changed insofar as investor preferences, at least as they relate to momentum. One-month, three-month, six-month twelve-month, and all flavours of formation period in-between, have maintined their "spread" out-performance between the best-performing and worst-performing deciles of stocks.

This is curious if only because there has not only been enormous liquidation and margin-puking going on, but mperhaps more importantly, other major world bourses, most notably the USA have seen their 3,6,12 & 36 mo momentum spreads get absolutely crucified by a magnitude of 25% - numbers not seen November 2002 and January 2001. As a result Calamos ( doyens of uber-momentum), and heirs apparent to Navellier (TOP20 Fund -25.4% peak to trough)has seen his formerly $20bn long-only fund pummeled 20% since mid May.

Why has the relative performance of winners and losers been so dramatically altered in the USA, but not in Japan? My guess is that inflation and its associated interest rate rises that people fear, are structurally perceived as posing greater earnings threat to the US market. This is exemplified by heightened conditional co-variances of "risky" stocks (i.e. stocks whose earnings have higher r-squared to changes in aggregate demand and aggreagte US earnings), that will (presumably) manifest itself from continued hikes in US rates. Most sensitive to this are primarily effect sectors most buoyed by the "liquidity trade" (materials, mining, cyclicals, housing, etc.) coupled with secondary effects of general deleveraging by hedge funds, which means, "selling what they own". This has caused BOTH accelerated sector rotation coincidental to intra-sector convergence - both which are anti-momentum effects.

Japan, by contrast, has been caught in the jetwash. This has seemingly caused marginal exposures across the board to be reduced, which has not caused excess sector rotation nor the intra-sector convergence that so defines anti-momentum (excepting the shortest of reversion horizons). Where does it go from here? The momentum effects in Japan appear to result from the attention certain stocks receive from large foreign admirers, be they hedge funds, activists, or large long-only shops. And I believe that these allocations are somewhat stickier than the marginal flows driving some fo the US style shifts, and so I see no immediate reversal. Until, of course, if and when, Japanese stocks return to ignominimy. As for the immediate direction, the selling has been overdone and today the 14th of June with many fine securities having shed 30% to 40% from values seen just a few months before, I strongly suspect a significant and profitable near bounce is on the cards.

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