06 April 2019

After a brief yield curve inversion wobble that momentarily shook our bullish resolve, US stocks have resumed their uptrend mainly led by technology names, pushing the closely watched Philadelphia Semiconductor Index (SOX) passed its all-time high recorded back in April 2018. In Japan, our top segment picks, semiconductors and factory automation plays have bounced back strongly for the start of the new quarter, encouraged by the likely conclusion of a trade deal later this month between China and the US. 

This week we want to focus more on our own market and more on developments in Japan which could prove important for other segments of the stock market for the medium to longer term. One of the most important of these was the announcement by Japan's finance minister, Taro Aso who discussed tentative plans to ease antitrust rules that would allow regional banks to finally begin merging and form more super-regional lenders.

This policy has long been needed to improve the profitability of these small financial institutions operating in regions where ageing demographics and falling population, together with BOJ's ultra-loose monetary stance have all conspired to hurt their earnings structure. We believe this change could usher a big realignment in the financial segment not seen since the late 90s when Japan's big city banks were forced to merge to form what they are currently regarded as mega-banks, to help tackle their non-performing loans left from the collapse of Japan's asset price bubble. Given the very attractive valuations of many regional lenders, we think this policy will undoubtedly create some interesting buying opportunities.  

As we have argued from the start of this publication in the past 12 months, we believe BOJ's continued oversized QE program is misguided as not only it has failed to spark much inflationary expectations, but it has had a notably negative impact in distorting the country's capital markets such as hurting JGB market liquidity and heavily distorting some stock price moves through central bank's Nikkei 225 ETF purchases. As BOJ's previous chief, Shirakawa-san had long warned, monetary policy is unlikely to be as effective in a country like Japan which is facing falling productivity from a rapidly aging population. 

Another key issue is that with 60% of Japanese companies being effectively debt free and Corporate Japan having generally long deleveraged in the post-asset bubble era, lowering the cost of debt has only forced banks into riskier loan assets and has not really helped the real economy. On the contrary, given Japan's ageing demographics, ultra-loose monetary policy has also hurt savers, pension funds and insurance firms while higher asset prices have failed to spark a self-sustaining domestic-led growth that BOJ's chief, Kuroda-san has long envisioned.

With October's consumption tax hike around the corner, although we might see the usual temporary surge in sales of big-ticket items before VAT is raised, it is questionable whether Japan's economic policies are co-ordinated enough to achieve the economic growth that the officialdom are hoping for. With BOJ having had to do all the heavy lifting of Abenomics and with monetary policy options now all but exhausted, Japan's structural reform much needed to tackle key issues is likely to set the political tone which we believe could ultimately threaten the very existence of the ruling LDP party over the coming decade.

All these leave Japanese stock market being as dependant on the export picture and highly sensitive to economic cycles as it has always been. This is the primary reason we have been far more focused on global market trends and take our cue from economic and policy developments unfolding in the US and China.

With the conclusion of trade talks between these two nations looking imminent, we highly suspect US hawkish trade policies will shift towards Japan and EU. In the case of Japan, US trade representatives are likely to set their sight on forex and the fact that BOJ's monetary policy has intentionally or otherwise, led to a notable depreciation of the yen which according to some trade hawks in the White House has led to a less competitive manufacturing landscape for US companies.

We think this will create its own political pressure on the BOJ to abandon its QE program and inflation target and ultimately allow longer term rates to edge higher. In such a scenario, such outside pressures on Japan not seen since the Plaza Accord of 1985, could ultimately lead to a surge in yen's value. So although a trade deal between China and the US should lift much uncertainties regarding investments globally, for Japan and indeed EU, trade tensions could only be starting.

All of the above, seem to be indicating to us that at some stage this year, we might have to adopt a more aggressive and positive weighting stance towards financial names at the expense of yen-sensitive manufacturing stocks. For more specifics and our current Japan long/short recommendation list, please contact us.