Research out from BCA|Edge points to a portfolio allocation strategy that in some cases ignores the sprinkling of economic wisdom recently dispensed by well-known hedge fund and asset managers.

In a monthly portfolio strategy out July 29, BCA reveals that it likes equity investing in Japan and prefers high yield and investment grade debt over government sovereigns. Overall the allocation is equally neutral on equities, fixed income or cash. In terms of sectors, they like energy, industrials, healthcare and info technology while not much liking consumer discretionary, consumer staples, financials and telecoms.

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Is stimulus at its end in Japan or with fiscal help is it the beginning?

There are two sets of arguments regarding Japan. One faction, perhaps represented by Ray Nolte of Skybridge Capital, says quantitative easing and central bank monetary policy has played itself out in Japan. The stimulus-driven rise in asset prices has played itself out and Nolte reduced exposure to the region.

BCA, for its part, does not subscribe to this thesis.

While acknowledging that growth and inflation data remains muted in the face of historic monetary stimulus, BCA sees opportunity in an emerging economic policy.

While monetary policy through central bank intervention has been asked to do the heavy economic lifting, Japan is the first country to break this recent cycle. They are expected to embark on aggressive integration of little used fiscal policy to stimulate economic growth.

Explaining their choice to overweight Japan amid other fund managers moving out of the region, the report titled “What Can Snap The Rally?” pointed to “helicopter money.” Helicopter money is a term that implies government spending that directly benefits the sovereign’s infrastructure and people as opposed to monetary stimulus which purchased both bonds and kept interest rates low.

It is this helicopter money trend in Japan that is driving, in part, BCA’s recommendation on sector investing.

Addition of fiscal stimulus could lead to stock market benefactors

Japan could be the first to set off a global trend towards integrating fiscal with monetary stimulus to prime the economic pump. Fiscal stimulus could be used to fix crumbling infrastructure and become the tipping point for fiscal and monetary integration.

The economic strategy is not without peril. Allison Nathan, a senior research strategist at Goldman Sachs, noted opponents say it could open up the central bank to political influence, it could provide elected leaders yet another excuse to “kick the can” on budget reforms and it could fuel inflation. Proponents argue there are few policy options remaining and it would be the most direct method to boost the economy rather than inflating asset prices.

Regardless of the hazards, if implemented the addition of fiscal stimulus to the policy tool-kit might create stock investing opportunity. For BCA, this leads to sector preferences.

The most significant boost in their sector asset allocation came with industrials, moving from negative to positive and, due to fiscal stimulus, now one of the highest ranked along with the Information Technology sector. The also like healthcare unrelated to fiscal stimulus – an investment that goes against their model – and they keep utilities at neutral because valuations are stretched.

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BCA: The government bond bull run is ending, still overweight high-yield debt but concerned

Government bond yields are headed higher and the 35-year bond bull market – the one that created legends such as bond king Bill Gross – is over. The report noted this trend could end in part due to fiscal stimulus bearing inflation. The reason given for the end of the bull is not that yields could not go lower (something which investors are short bonds have learned the painful way) but rather that BCA believes populism could change fiscal policy – likely a reference to Donald Trump and Hillary Clinton attempting to woo Bernie Sanders who are viewed as populists by many supporters and detractors. Specifically, BCA opines:

We think the 35-year bull market in bonds may be near its end, particularly since populist political trends suggest fiscal policy will be rolled out in major economies over the next few years.

The shift won’t happen immediately, but BCA thinks fair value on the US Ten Year Note, for instance, should be in the 1.5% to 2% range. The yield is currently 1.54%.

While BCA is overweight high-yield debt, they are worried about being paid for risk. High yield debt is a risky proposition, particularly in a rising interest rate environment. With yields so low, the principal risk is high, but nonetheless BCA gives the investment category an overweight.