05 August 2018

The Japanese stock market has regained its status as world's second largest as Chinese shares continues to come under selling pressure over worries over a trade war with the US. This could help our market attract more attention, perhaps more as a haven given current geopolitical uncertainties. However, for this week will remain focused on BOJ and its subtle change in its nuance in its monetary policy which we have been hoping for. 

Although the reaction of most economist were muted by the fact that BOJ had left its JGB purchasing targets unchanged, we continue to believe that the central bank is laying the foundation for policy normalisation and it has already been tapering with its purchases in the last 12 months falling way off target of annualised Y80trn level. With Kuroda-san hinting for more flexibility in allowing rates to rise (or fall), we think the bank was clearly signalling its intentions to begin the normalisation process despite Japan's weak inflation rate. 

As we underlined last week, pressures on BOJ to normalise has been rising to improve the operating environment for banks, insurers, pension funds and savers. With US policy makers also naming China and Europe as currency manipulators, Japanese politicians have also become aware of the current dangers of central bank's monetary expansion strategy which has yet to spark rising prices. 

As we have also highlighted with rising input costs starting to get passed on along the supply chain, and with unemployment at record low of 2.2%, labour shortages are starting to lead to higher labour costs. Thus, we believe there is good reason to expect the rise in Japan's CPI to gather more momentum. All of the above factors seem to be indicating a steeper yield curve which we continue to see as very positive for Japan's financial stocks, particularly its big banks and insurance firms. 

With prospects of rising rates at home and in the face of rising currency hedging costs, concerns over Japanese investors reducing their overseas bond holdings have been rising, keeping the yen relatively firm against other major units. Although we don't expect any major moves in the shorter term, we think the probabilities for the yen to appreciate further from here is rising for the medium term. 

Japan's earnings season is drawing to a close with generally decent results thus far although there have been some outstanding misses also. Moreover, the outlook has understandably become much more cloudy for the next few quarters, leaving us cautious as we have been for much of this year. We have greatly reduced our number of short picks in semiconductor-related segments in the past few weeks, focusing more on finding highly overvalued domestic names which have been perceived as more defensive plays in the face of increasing uncertainties in US trade policies. 

One such name that stands out is the much-loved cosmetic specialist, Shiseido (4911) which has seen a huge re-rating on skyrocketing sales to Chinese consumers. With its Q1 earnings having doubled YoY, its own modest growth expectation are likely to be revised up. However, some analysts are already projecting 40% higher full-term earnings growth with average forecasts nearly 30% above the firm's own guidance. 

Although its Q2 earnings due out this week should also be strong, we added this name to our short picks early last month as we think its rising marketing costs along with higher depreciation charges will begin to weigh on its profit growth, especially going into next term. As its short and long-term charts are all signalling an overbought situation, we think its technicals also look good for shorting. 

Moreover, with the yen reaching its 18-month high against the Chinese currency, potentially hurting inbound tourism from China, we think Shiseido's growth outlook from the second half could prove disappointing. With most sell-side analyst recommending buying its shares which have risen by over 800% since 2012, we think expectations for growth are very high as reflected by its rich earnings multiple of 40x. Thus, we suspect any caution expressed in its earnings outlook on the 8th of August could lead to a severe sell-off. 

Another one of our short sell picks, Taiyo Yuden (6976) which we touched upon in our 22nd of July publications is also reporting its earnings this week, on the 6th of August. Although its capacitors business should be growing at strong double-digit levels, we suspect its high frequency filter business will remain weak and believe the highly anticipated price hikes in MLCCs has been factored into its share price which has more than tripled in the past two years. To view all our current long/short picks, please contact us.