Fed’s pause received well while trade talks looking very promising

S&P finally breaks to new highs as short-term hurdles cleared 

After showing some anxiety about trade, some weaker corporate earnings, mainly from industrials and concerns about the general economic slowdown in earlier part of last week, US stocks pushed higher at the end, leading the S&P Index to finally break out to new highs and entering blue sky territory. The latest strong US employment data seem to suggest that the Fed’s monetary policy might not be as behind the curve as some bearish economist might have thought only a few months ago. With October crash avoided and market taking weaker earnings in its stride, we don’t see much obstacles for further gains in stocks in the near term. 

Fed’s pause was received well while BOJ’s inaction also encouraging
Fed’s stated pause after its recent easing policy was taken well by the market as the low probability of further cuts this year have become a consensus outlook. As we also expected, BOJ did nothing again in its latest policy meeting. We think the central bank is taking a step back to monitor the immediate results of its tapering which have not created much stress in either the JGB or the currency markets. We think these are providing encouraging signals for BOJ to pursue the policy of drastically cutting its bond purchases in long-end of the curve and try to steepen it to help its financial system.

Japan looking poised to outperform other DMs
We strong believe that BOJ has finally realised that without a healthy financial system backdrop, bigger QE programs are not only futile to stimulate the economy but could prove dangerous to Japan’s financial structure. This is significant in our view and should ultimately help financials stocks to continue to outperform as they have done so from late August. Since then the BOJ chief, Kuroda-san has tried to weave this illusion of more potential for loosening policies while actually tightening conditions. So far the policy has brought positive results and we continue to expect the cyclically sensitive Japanese stock market to outperform most other DMs, especially as it has notably lagged even the German stock market which remains as cyclical by nature but once facing weaker earnings recovery prospects in our view. We retain our Topix target of around 1900 level before year-end, close to its 2018 high and leaving it with 13% more upside. 

Trump likely to postpone December tariffs and move towards Phase Two talks
As pointed above there has been little bit of anxiety creeping in regarding the potential trade agreement between US and China beyond the phase one hurdle. With the current structure of China’s state-owned enterprises which concerns its long term economic policies completely off the negotiation table as the Chinese have clearly stipulated before the phase-one talks resumed, clearly the Trump administration has had to lower its sights to how far Chinese could be pushed without threatening its economic system. Indeed, the current low key state of the China hawk, David Navarro in the most recent talks which have mainly involved more moderates on the US side like Kudlow, Lighthizer and Mnuchin, seem to suggest that Trump wants to progress fast from here.

China realising a Democrat president could be even tougher than Trump
We see positive noises regarding a Phase Two agreement to appear as soon as Phase One deal is ratified. However much depends on Trump’s stance on the coming tariffs in December which we believe will most likely be further postponed. We also believe the Chinese have quickly realised that any deal must be struck fast as Democratic presidential candidates are becoming even more hawkish, pledging tougher policies to deal with China but more on multi-lateral basis that promise to include America’s allies.