31 March 2018

We remain highly cautious of momentum stocks in Japan going into the month of April and expect more share price weakness ahead. We also suspect this fast manifesting negative feedback loop which is eroding confidence in buying the dips, mainly coming from the US market, will keep the yen strong as a risk-off safe haven. With quarterly reporting season just around the corner we think Japan investors are becoming very mindful of 3/19 earnings guidance risks as most multinationals will likely to assume Y$ rate of around 100 level.  

Besides trade tensions with the US, we think recent changes in key posts in the White House strongly suggest a more hawkish military stance that could further rattle nerves. We certainly think these changes have increased the risks of US to unilaterally denounce the nuclear agreement with Iran, raising tensions in the Middle East and most likely leading oil price higher.

It is also worth noting that thus far, OPEC's production cuts seem to have mainly benefited the US frackers which have predictably cranked up output and have raised their market share and are now boosting their exports. Thus, although higher oil and gas prices might not be too negative for the US economy, it does hurt Japan and raise input costs. This will be partially muted of course by the stronger yen. 


In the US, calls for more regulatory oversight of social media firms, namely Facebook and what looks likely to eventually include Google, seem to be adding more concerns that some of the leading names of this historically long bull market are suddenly looking vulnerable to regulatory risks. Tesla's own issues with its latest car crashes and fatalities, continued production problems with its Model 3 and its high cash burn which have led to its credit rating being slashed have also not helped sentiment.

Add the likely disappointing unit sales of Apple's latest iPhones, generally weak global smartphone sales in saturated markets, improving 3D NAND yields which are driving chip prices lower than what bit growth can offset, and the coming flood in LCD supplies from China which have already hurt panel prices, all seem to suggest that surprises look to be on the negative side for now as expectations still remain fairly high, especially as we go into the earnings season. 

We generally suggest a more defensive portfolio in Japan, avoiding names with big foreign share ownership as we expect overseas investors to remain net sellers for now. We have produced number of notes last week, underlining our thoughts on some of our top short sell picks, some facing notable disruption risks, and some look blatantly overvalued relative to where we think they are in their industry cycle. We also see some buying opportunities in small and mid-cap space amongst some secular growth names.

Moreover, we have recently identified number of very liquid fundamental pair trade opportunities in Japan which we think technically also look attractive. Indeed, we strongly suspect pair trades are looking to make a big come-back as an investment strategy in Japan and elsewhere, giving L/S funds prime opportunity to show their skill-set. 

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