06 July 2019

Global stock market technicals looking strong
The upward bias in global stock markets, led by the US and fuelled by expectations for easier monetary policy remained intact as the melt-up scenario that looked possible back in late April looks to be unfolding. With Dow Jones Index nearing the psychological 27K mark, last tested back in October of last year while S&P 500 having broken above all its remaining resistance lines, technicals certainly look good for more upside.

But much depends on Fed turning more dovish
However, with underlying corporate earnings clearly showing signs of weakening, much rides on Fed's more dovish stance with as much as 25bps cut in the fund rate looking fully discounted for the next meeting this month. Although the June US employment numbers released last Friday came much stronger than expected, raising doubts about how much room Fed has to loosen, expectations for a more aggressive rate cuts remain high given the generally weaker indicators overall.

Resumed trade talks positive but China demands all US tariffs to be removed
With US and China resuming trade talks, the Chinese have unambiguously resounded demands that all tariffs introduced on China's exports to be promptly removed. China is in turn said to be looking to quickly resume purchases of some US agricultural products as a show of good will.

Rebasing of export capacity out of China to continue whatever happens
Although a trade deal will be very welcome as it will remove some of the uncertainties that have severely impacted global corporate spending, we suspect that rerouting of US bound export capacities from China will continue. Indeed the growing air of distrust between US and Chinese policy makers have left CEOs with little choice but to mitigate risks of another spat and a trade agreement is unlikely to alter their medium-term plans.

Japan stocks continues to underperform
However, one stock market that has not responded as bullishly to the above developments is our own as Japan's Topix index has yet to even reach late April's highs, just before the trade talks collapsed. With the Japan's stock market remaining highly geared to economic sensitive plays, concerns about weakening corporate earnings is dimming hopes among overseas investors who have remained net sellers.

Among developed markets, Japan has most to lose from US/China trade conflict
As we have argued, Japan which has the highest level of its trade surplus with China has the most to lose within DMs from US/China trade conflict as weakening Chinese capex, especially in the high-end segments of automation and semiconductors have made a big dent on industrial orders. We think the coming corporate earnings season will look fairly poor with stronger yen unlikely to help matters.

Consumption tax hike looking untimely and doesn't help matters
Moreover, an untimely consumption tax hike planned for October remains on the government agenda. Indeed, policy makers are defending the coming duty hike by predicting that Japan's VAT will not be raised again for another 10 years. Meanwhile, they claim that there has not been much signs of front-loading of purchases for big ticket items that could spell an ensuing fall-off. However, one could argue that if there has been no visible boost to consumption ahead of the coming tax increase could, it could be signalling an anaemic state of household spending rather than the nation's resilience to a higher VAT.

BOJ talks the talk but has limited room to stimulate the economy
As far as BOJ is concerned, policy decisions there are not looking much better. The central bank's key figures continue pay lip service to how there is more room for accommodative monetary measures should the economy warrant it. With fast ageing demographics and falling level of work force keeping Japan's employment at record highs, there seems to be a false sense of security among the bank's officials that Japan's economy will remain fairly stable even after the consumption tax hike.

Decade old ultra-loose monetary policy having limited benefits in Japan
Come what may, with Japan's financial industry already reeling from lower rates, pension funds and insurance firms as well as lenders, all calling BOJ to reconsider its policies, it is more than evident that BOJ's hands are very much tied in trying to boost activity. With over 40% of corporate Japan virtually debt free, the impact of ultra-loose monetary policy in Japan has had a fairly limited impact in creating leverage which we have seen fuelling growth in the US.

Japan central bank looking to steepen the yield curve
Indeed, BOJ's recent QE operations clearly suggest its desire to steepen the yield curve to improve operating conditions for its financial industry. We think the BOJ chief, Kuroda is coming under increasing pressure to abandon its 2% inflation target and his zero-rate policy. However, the key concern is the currency now. Although the Yen/dollar rate has recently bounced off from its crucial support line of 107, the above scenario seems to suggest the stronger yen could be with us for a while.

Yen strength to continue either way
Either the Fed will cut the rates more aggressively as market hopes and shrink the rate differentials or it won't and that could switch us back to a 'risk off' mode. Either way, the yen's strength could continue or at least. should hold on to its recent gains, creating more headwinds for the coming guidance of Japanese corporate earnings.

Japan spat with South Korea creating more uncertainties in tech space
If that was not enough, we also have Japan and South Korea in danger of a trade war over WW2-related issues which remain unresolved with both parties looking increasingly hostile. With Abe's government putting export restrictions on some semiconductor materials and gasses, requiring individual licences, and having seen what has happened to Huawei more recently, Samsung's chief is due to promptly fly to Japan to discuss matters with government officials and suppliers.

Samsung and Hynix account for 40% of global IC capex
South Korea has also threatened boycotting Japanese goods, leaving much uncertainties facing Japan's tech material makers as well as the potential to include restricting exports of component and equipment supplies from both sides. Considering the sheer size of Samsung and Hynix which together account for around 35% of total global semiconductor capex, such disruptions could prove costly for Japanese suppliers in the upstream.