US stocks continue to struggle ahead of earnings but no signs of panic
US stocks continued to struggle to make further gains for the third week in a row as investors remained concerned about political uncertainties derived from the potential impeachment of the US president, not to mention, the ever growing list of economic data suggesting that the economy is slowing as jobs growth weakness and business sentiment in the service sector starts to follow the manufacturing segment which has been in a recession for months. However, looking at market’s fear gauges such as VIX which remains close to historic lows or the yen which we think is even a better barometer of global risk sentiment, there doesn’t seem to be much concerns about the potential downside for now. With earnings season upon us, we think it will be interesting to see if investors are less likely to give corporates the benefit of the doubt as in the previous two quarters when weaker results were ignored and rosier outlook kept investors optimistic, especially in the more cyclical segments.
We retain our bullish stance on Japan and advise going long Topix, short Nikkei
In our own market in Japan, stocks have also trimmed their September gains as Topix failed to clear its key 1630 hurdle having fallen back to its 200 day moving average just above Y1570. However, we retain our bullish stance which we adopted back in August as we see growing evidence in some key segments, namely semiconductors and factory automation to be turning around. We also continue to expect BOJ’s tapering of its long dated bond purchases to help the financial segment which has been a long-time market under-performer. In fact it is our view that the time has come to see the broader market measure, Topix outperforming the Nikkei 225 index having greatly lagged it for the past several years as NK225 ETF purchases by BOJ has created big opportunity for this to reverse course. Should BOJ tapers its ETF purchases which we think is only inevitable, then this pair trade could outperform significantly.
Japan investors more focused on trade talks than worried about consumption
With Japan’s consumption tax hike having come to pass, we don’t see much signs yet of investors running for cover, especially as consumption in Japan has been generally weak as underlined by the absence of any major uptick in spending in big ticket items before the the tax levy was raised. With Japan’s stock market much more geared to global manufacturing cycles than domestic consumption, investors seem to be far more focused on the coming US/China trade talks which some indications suggest we might see some compromises by both sides to keep the markets happy for now.
Promising signs by both sides ahead of US/China trade talks
With China reportedly ramping its US soy bean purchases, talks of it further opening of its financial markets to US firms and seemingly allowing for some pending M&A deals to be approved sooner than feared, it does seem to want to make some goodwill gestures going into talks next week. On the US side, with Mr Trump having completely ignored the clashed in HK, and having congratulated the Chinese premier after the nation’s 60th anniversary of the communist rule, it does seem that planned tariff hikes are likely to be postponed further into next year to buy more time as we move into the US presidential election year. So we see more scope for positive surprises that could help the markets rebound towards their September highs than negative ones.
Yen not strengthening as much as we had feared as BOJ tapers
What is also encouraging is the movement of the Japanese currency against the dollar. Although we have been greatly anticipating BOJ’s move to try to steepen the curve by tapering its over-sized QE program in the JGB market, we had also feared that this more blatant regime change could lead the Japanese currency to notably strengthen and push the unit to test parity against the greenback. However, the very recent yen strength seems to have been only sparked by weaker global economic indicators that has tilted the market towards a more risk-off mode. Indeed, BOJ’s tapering which briefly reverberated across the world’s government bond markets didn’t seem to immediately spark any major yen buying as we had feared. If the Yen/Dollar rate can hold its levels above that psych line of 105 despite BOJ’s so called “reverse twist” operation, then the central bank could be encouraged to make further cuts in its JGB purchases in the coming months.