02 September 2018

As we noted last week, we think the probability of an all-out trade war between the US and its big trading partners have risen significantly as the US president and his advisors seem to be turning increasingly hawkish towards trade agreements with Europe, Japan and obviously China. With key trade talks with Japan due to start this month, and the US increasingly likely to declare that importing overseas-made cars are a threat to national security, we think Japan's auto segment looks firmly in the firing line of this trade war, with one of our top short picks, Subaru (7270) probably the most exposed in terms of its gearing in sales of Japan-made cars in the US.

With many of the US's trade decisions looking to be decided this month, just before the US mid-term elections get underway in November, we retain our generally cautious stance on the Japanese stock market, a strategy which we have stuck to for much of this year. With rising US rates and the stronger dollar are continuing to wreak havoc with EM currencies, and China slowing, we think there are good reasons to be cautious about the Japanese market which tends to be very cyclical in its nature. Although we continue to think Japanese stocks are very attractively valued relative to underlying growth and compared with other large markets while scope for higher shareholder returns make the market very attractive in the medium term, for the shorter term we remain negative.

Besides autos, another segment which to us remains vulnerable to further derating is semiconductor production equipment makers as we see more signs of the IC memory market peaking while the more opaque pricing in foundries also looks to be trending lower. This will keep a cap on capital outlays which we think have risen to unsustainable levels, especially given the growing shortages of wafers which limit both growth and outlays on new lines. With flat panel capex also shaky, we have identified a number of Japan's high-tech equipment suppliers which we think remain on a notable de-rating track and which we retain in our recommended short sell list including Sumco (3436), Horiba (6586), Advantest (6857) and V Tech (7717).  

However, it is our long picks in the sector like TDK (6762) and Sony (6758) which we have been particularly pleased with as their shares have broken multi-year highs as their secular earnings growth trends continue. We have also been recommending to pair these two longs against respectively shorts Taiyo Yuden (6976) and Panasonic (6752). We think Taiyo Yuden's big rerating looks unsustainable here while we suspect Panasonic will feel the impact of the industrial slowdown in China and a possible pricing war in the global auto battery market.

We are also pleased with the rebound in our fairly recent long addition, Rakuten (4755) which we continue to view as notably undervalued relative to its earnings growth potential and one which we have also addressed in our past weekly notes. One sector name which we would aggressively short against Rakuten is Cyberagent (4751) which has recently bounced on its possible Nikkei 225 inclusion this month but in our view remains hugely over-hyped and over-valued. Moreover, we view going long the Cyberagent CB against its stock an attractive structure and we would strongly recommend this switch to existing CA shareholders. For the complete list of our recommended long/shorts, pair ideas and other structures, please contact us through our website.