07 October 2018

Although the weaker yen has boosted hopes of better prospects for Japanese corporate earnings, externally there are darker clouds gathering on the horizon that makes us cautious again about the market's immediate outlook. There seems to be two events unfolding at the same time which have greatly raised uncertainties about the global growth outlook going forward. 


One is the surging US bond yields as economic activity remains red hot in the US with unemployment rates hitting their lowest levels in 50 years with rising input costs and wage inflation all becoming more notable. With the Fed hinting of a more restrictive monetary policy stance in 2019, the ten-year liquidity-driven rally in the US stock market looks to be slowly drying up as the risk-free rates edges ever higher making share buy-backs by US corporates increasingly tough to justify. 

With expanding interest rate differential between the US and Japan, the Y$ rate has reached a significant resistance around 114 level which if cleared could pave the way for further weakness in the Japanese unit. Besides the growing appetite for US treasuries by Japanese institutions, we are hearing more about yen carry trade positions rising significantly again in recent weeks by non-Japanese investors.

We believe this currency trend has become increasingly worrying for Japan policy makers which want to avoid being seen by the US as manipulating the currency to boost Japan's exports. With the Trump Administration having softened its stance on trade with America's traditional allies, but increasingly likely to go into an all our trade war with China, Japan will want to avoid any further hurdles on trade deals with the US. In fact, we would not be surprised to see Japan's officialdom to start talking the yen up from here. 

In turn, we believe this adds even more pressure on BOJ to taper its oversized and unwarranted QE program which is now becoming a huge political burden. With savers, pension funds, banks and insurers all speaking out against the continuation of this monetary expansion experiment which has pushed BOJ's balance sheet to equal the size of Japan's GDP, we believe we are at a cusp of a significant regime change in Japan's monetary policy which is already pushing long term JGB yields to their two-year highs. This as we have explained in previous weeks keeps us very bullish on Japan's financial stocks which are big beneficiaries of the steeper yield curve.

The second major global event unfolding is the deteriorating relationship between China and the US, with examples such as China not allowing US warships to dock in the HK ports, and oil imports from the US also drying up, probably in favour of importing more from Iran. Talks of China's latest move to crack down on its travelers returning goods with luxury items and cosmetics have also alarmed investors with our Shiseido (4911) short idea starting to generate strong alpha.Talks of granting less student US visas to Chinese students who might want to study in America must also be a very worrying issue for Silicon Valley firms. 

However, the latest bombshell came from a revelation of Chinese spy-chips possibly being found on US servers, allegedly used by the likes of Apple, Amazon and US armed forces. With the likes of Lenovo (992) seeing its share price sink by 15%, the market is suddenly contemplating the possibility of US imposing bans on use of Chinese-made servers which currently make up majority of those made globally.

It would be interesting to see what will happen to share prices of Chinese tech names like ZTE (00063) once the Chinese market opens after its Golden Week holidays. With this trade friction looking increasingly confined to technology segments, US and Japan tech stocks are coming under more selling pressure. Although we have lightened up a bit on our list of tech shorts more recently, we still have plenty of names we would sell here such as Advantest (6857), Daifuku (6383), and Taiyo Yuden (6976). 

One final thought we like to touch upon regards Sony (6758). We removed this name from our buy list last week ahead of its earnings results at the end of this month as we expect much of the short term positives to be factored in. Having rallied by 150% since we added it back to our buy list in Jan 2016, we think the time has come again to take profits in this crowded trade and wait to see how much growth has already been factored in for now. With 17 buy ratings, 7 holds and no sell calls in sight, we felt increasingly uncomfortable being in this bullish consensus.