Stable economic growth, abundant liquidity, the relative attractiveness of stocks to bonds, and signs of investor confidence could help lay the foundations of a strategic bull market in Japanese equities, according to Zhen Wei at J.P. Morgan in Hong Kong, and one way of profiting from such a market would be to implement a macro-regime based momentum strategy.
Wei shows that momentum has been the best performing asset allocation policy in Japan over the past 30 years (see chart) and momentum signals have been pointing to tactically long Japanese equity positions for more than two years in a row. As such, Zhen Wei suggests a rotation strategy for the Topix 17 sectors based on economic regime and momentum.
Specifically, according to a classification of cyclical/neutral/defensive sectors, his Japan sector rotation strategy systematically longs a basket of cyclical sectors (if the economic trend is going up) or defensive sectors (if the economic trend is going down). The number of sectors in the long basket is determined by absolute momentum, which is defined as 12-month (or 3-month) return if the economic trend is going up (or down). Each sector in the long portfolio is assigned a 20% weight and unallocated weights are invested in 10-year JGB government bond futures.
Between January 1999 and April 2014, the strategy delivered an excess return, Sharpe ratio and maximum drawdown of +9.2%, 1.02 and -10.9% respectively. In comparison, the Topix Index delivered an excess return, Sharpe ratio and maximum drawdown of +2.1, 0.21 and -60% (see chart).