July was yet another factor-led market in Japan as well as the rest of the world with Growth strongly outperforming Value. The spread was around 4~5% in Japan (depending on which index one uses); the S&P 500 Growth index outperformed the Value index by a whopping 7%! In fact, the S&P 500 Growth versus Value outperformance was the 4th widest since both Growth and Value indices became available (from mid-1995). The first and second widest were, not surprisingly, in 2000, right around when the markets peaked and just before the IT bubble burst (the 3rd was a few months after the Lehman crisis but before we hit the ultimate floor in mid-2009). In all such cases, it was an ominous cloud of something worse yet to come.

 

As such, while the underperformance was disappointing, I believe we fared fairly well for a value-tilt strategy, especially as we had sought to reduce high-beta and global, cyclicals in the months prior. Furthermore, July is pre-earnings season and, therefore, stock returns are more prone to factor movements. In our portfolio, we had 4 out of the 16 names announce quarterly earnings in July, all four of which were smaller positions and two of which were on the last business day of the month and thus did not contribute to returns (among them, two stocks reacted positively post earnings announcement while the other two moved in-line the market).

 

Looking back, I’m at quite a loss as to understand this growth-led bounce in July given all of the (fundamental) negativity, whether it be inflation, negative GDP growth, and the seemingly endless warnings coming out of companies in the US. I read an opinion piece on Bloomberg that mentioned that the IMF described the global economy’s prospects as “gloomy and more uncertain”. The author went on to say that “having worked at the fund for 15 years earlier in my career, I can assure you that officials there do not use words such as ‘gloomy’ lightly.” I’ve read possible reasons for the rally such as liquidity (as of July end, fed funds futures were already pricing in a cut in interest rates from as early as Feb 2023, although as of today, this has been pushed out to May 2023 after the strong payrolls number last week), valuations (since the S&P had fallen -20% since the start of the year to the start of July and -30% for Nasdaq), and relative attractiveness vs other asset classes. I don’t know much about the latter, but the first two reasons seem odd to me. As I always caveat, I’m no macro-economist, but it’s hard to envision such an immediate about-face in just one year, especially during this inflationary environment that probably won’t turn a corner overnight. Sure, the US CPI may have fallen slightly in July but 8.5% sounds pretty high to me and still considerably far from the 2% target. During the first and second oil crisis, inflation rose for 2 years. After the second oil crisis, it took 3 years for inflation to return to previous levels. And while the Fed did cut rates fast, it was from 20%, not 3~4%. As for valuations, while they may look cheap, the market still has S&P500 forward 12M (positive) EPS rising +11% and Nasdaq at +12%. Expectations feel a little high compared to the news flow we’ve heard in July. And if it really is that strong, why would the Fed need to cut rates? The two expectations seem mutually exclusive. And even if those EPS estimates are correct, I’m not sure if I’d call the S&P’s 18x earnings or 12x EBITDA cheap (TOPIX is at 12x and 8x respectively with only 4% (positive) EPS growth, by the way).

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Ultimately, I think it’s simply that we’ve gotten so used to liquidity and we reason that the Fed will always save the day, despite what they are saying. The only problem is that very few of us have lived through an inflationary environment (unless you were a professional investor during the 70s). So, none of us, except maybe people as experienced as Warren Buffett, can guess how slow/fast inflation moves, how the Fed policy may or may not change, and, most importantly, how the market will react.

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As always, there’s little we can do as we do not “play” the market. The fundamentals feel to be at risk for the price being paid (i.e. the margin-of-safety may not be as wide as it seemed), particularly for the global cyclicals and economically-sensitive companies, which is why we had preempted to reduce that exposure. Of course, we haven’t removed it completely but have worked to reduce it. We’ve kept the domestic exposures, particularly those that we feel can weather the storm that seems to be coming a little better than others. Separately, we’ve started to think about where we want to be positioned 12 months from now and under what scenarios.

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And so, in the meantime, we will see whether fundamentals have actually turned or whether, like past cases where the spread was similarly wide, it was a dead-cat bounce. Despite July’s factor movements, we continue to be very comfortable with how we are positioned.

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Masaki Gotoh

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“I would admit I’m an introvert. I don’t know why introverts have to apologize.” – Bill Gross, co-founder of PIMCO.

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Some people, even those that know me fairly well, might be surprised to hear that I, too, am an introvert. This isn’t to say that I like being alone; quite the contrary, I absolutely HATE being alone. But, to this day, I am extremely uncomfortable in settings where many unrelated people mingle in a single room. I’m ready to leave a party after 30 minutes. I hated clubs when I was younger; I did work as a DJ for a summer, but that was OK because I wasn’t on the floor and I could be in my own zone, away from the crowd. It takes time for me to really get to know someone as I am naturally suspicious of new people.

 

As a child, we moved frequently and never lived in a single location for more than 3 years, so I repeatedly had to change schools. This did teach me playground rules and I learned to make new “friends” very quickly. I certainly was never in the popular, “in” crowd, but I was able to maneuver between different cliques from an early age and learned how to be liked by a variety of people. I also moved around professionally, but rarely had difficulty blending into the new work environment. I even joined Toastmasters for 4 years to overcome my fear of public speaking. But, in all of these cases, I was socially active because I had to in order to survive and succeed. Over time, it became natural and almost instinctive. I actually became rather good at it and could ad lib quite well; I’ve been best man in 4 weddings, but I never prepared a speech (but always got a good laugh or two between praises). Still, I never overcame the discomfort. Thankfully, my older son, Leo, has not been cursed with this impediment, probably taking from his mother, who is my complete opposite in this regard, as she is perfectly happy to be alone but is quite the extrovert. My younger son, however, has been inflicted with my deficiency. And I know from experience, there is no remedy. He’ll have to learn, as I have, through trial-and-error.

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One of my biggest regrets in life was not making (and keeping) more acquaintances, especially from business school and work. I’d try to skip the corporate events or, if I had to go, I’d just hang out with my close friends. And those large conferences were a nightmare. Having become better at public-speaking, I’ve often been asked to present a topic or join a panel which is the only reason why I’d attend a conference. That, I didn’t mind at all. But I am still terrified of the cocktail hour afterwards. I’d try to stick with someone close who did know how to navigate the room. I’m sure we all know a few, and I’ve always been so envious of such people. They’d glide around the floor like a ballet, and everyone seemed to love them. I’d try to keep up by tagging along behind them like a faithful dog, and they’d introduce me to dozens of people, probably out of pity for the hermit that I am. But they’d eventually leave me because they are pulled away by another social butterfly to introduce them to someone “you must absolutely meet!”. And so, I’d be standing with a group of random people whom I’ve never met, inevitably all of whom are as shy as me. And none of the other gliders would ever join our reclusive little group (I think they sense introverts), so we’d end up talking about the hors d’oeuvres in order to fill that uncomfortable silence until we break off to refill our wine (which we’d be chugging because there’s nothing to talk about). Ultimately, I’d silently leave the party, and no one would ever notice I left. The next day, I’d just leave the stack of business cards I received in the pile at the corner of my desk.

 

So recently, as we slowly moved out of the pandemic (it was only early this past April that Japan declared the end of the state-of-emergency), I took it upon myself to contact a few old colleagues from the past. One thing led to another and, the next thing I know, I became busy with weekly work-related lunches and dinners with people outside of the office. In June, I had 4 such dinners and 2 lunches and, in July, I had 7 dinners. In addition to the 1~2 non-work dinners and the 1~2 evenings of babysitting (so that my extroverted wife can go to her wine events), my weeknights were full for 2 months! This is after 2.5 years of nearly zero such lunches and dinners. I doubt if I can keep this pace up (I only have 4 in August and zero set up for September while my wife continues to block evenings as far out as November), but it was definitely fun to catch up with many old colleagues and, actually, fairly helpful from a professional perspective as well.

 

But what I found most interesting was that almost everyone I met were commenting similarly, and they, too, had become much busier with lunches and dinners too. I did have difficulty with restaurant bookings and taxis seemed slightly harder to catch. And this is all while new case counts are making all-time highs again (we hit nearly 250,000 new cases a day last week, over 2x the previous wave which was, itself, 4x more than the wave before that). We are yearning for face-to-face contact. Out of the 20 post-earnings 1-on-1 meetings we have confirmed to date this quarter, 16 meetings or 75% are in-person (group meetings are still mostly via Zoom). We had about 60% in-person meetings out of the 32 1-on-1s during the previous quarter (right after the state-of-emergency was lifted) and less than 30% in-person meetings out of the 29 1-on-1s set up in the quarter before that (which was during the state-of-emergency).

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This isn’t to say everything is back to normal. According to a website managed by NHK, which is Japan’s only public broadcaster, foot traffic (using cellular data) of the three major night-life areas around Tokyo (Shinjuku, Ginza, Roppongi) are averaging about 60% of pre-pandemic levels. During the day, Shibuya, famous for their busy crossing and home to many IT firms, is averaging 50% on weekdays and 60% on weekends. Tokyo station, which not only houses many corporate headquarters, but is the major hub for both leisure and business travelers, is also running around 60% on weekdays although closer to 90% on weekends. However, there are other major metropolitan hubs around Japan that are near, at, or even above, pre-pandemic levels including Yokohama, Nagoya, Kyoto, and Osaka. In fact, most cities outside of Tokyo are at 90~100% pre-pandemic levels. Tokyo is lower for two main reasons, 1. An abundance of white-collar workers at large corporations where remote work was rolled out quicker and 2. a high concentration of traffic from non-nationals. Given the recent jump in new case counts as well as the summer Obon holidays, these figures have fallen slightly in the last month. However, if my anecdotal evidence is any guide, we suspect it will begin to pick up again. Furthermore, the government has slowly but surely been easing entry requirements for visitors. As I’ve repeated many times in the monthlies, it’s a matter of when, not if.

As I try to be more like my adventurous son, Leo, and meet more people face-to-face, I think we all will be doing so more regularly. It’s a glimmer of hope during what seems to be darker times.​​