08 July 2018

The markets ended the week on a more positive tone, hoping that China refrains from imposing tariffs on US goods and cooler heads will prevail. Although China did introduce its own import duties in retaliation of US tariffs as it had forewarned, by all accounts it was a measured response as it has been very careful not to fan the flames while not being seen as weak either.

With China having banned some of Micron's chips last week, concerns of different tactics being used in erecting trade barriers have also raised market tensions. Having banned US firms from buying from or selling to ZTE last month, US lawmakers seem to be shifting focus towards China's other telecom equipment giant, Huawei, asking Google to reconsider working with the Chinese firm while raising questions about how much of US carriers' current infrastructure is using their platforms. Also, the latest move to block China Mobile from entering the US market is another reminder that tariffs are not the only disruptive measures that both sides are likely to use.

Moving away from trade, the coming NATO summit this week on the 11th July, will most likely only highlight the widening cracks appearing between US and its foreign policy and those of its allies on key subjects like Russia, Israel, Iran and Turkey itself (a NATO member). We suspect market concerns could quickly shift away from just trade to security issues as US will likely to be demanding more financial contributions from other member states while wanting all its NATO allies to toe its line on its unilateral foreign policies on dealing with those countries.

With EU's structural integrity also under pressure from Brexit, its immigration policy that has yet to address key issues, populist Italian government threatening to tear up EU's fiscal rule book, separatists in Spain, and those in Scotland who want to remain in the union, the global political backdrop has not looked this messy since perhaps the run-up to the Cuban crisis, if not the previous two great wars. Even North Korea is now responding negatively to the latest meetings with US officials, declaring that a unilateral denuclearisation that Americans are demanding is simply out of the question.

Needless to say, all of the above factors should continue to keep markets very nervous and temper the growth outlook for Japanese corporate earnings.  We firmly maintain our negative stance mainly on techs, machinery and auto-related names which should remain under selling pressure as foreign selling of Japanese stocks should continue for now.

The SEMICON West show also under way next week could provide much anecdotal evidence that semiconductor market is slowing. With smartphone market saturated and replacement demand cycles lengthening there, crypto-mining activity falling off the cliff from ridiculously elevated levels, foundry activity also looking much weaker going into the traditional busy season, NAND prices under pressure as 3D production yields are rapidly improving, DRAM overcapacity looking increasingly likely by the year-end, flat panels under severe pricing pressure and OLED yields simply not high enough for others besides Koreans to ramp up, we are not expecting much good news to be emerging from the conference.

One contrarian long pick which we have recently added to our recommended list is Rakuten (4755).  We believe there is a good chance for Japan's e-tailing giant to either forge an equity tie-up or be bought out by the likes of Walmart which has been expanding its battle ground with Amazon globally. At less than 5x EV/EBIDA, and having plunged 70% from its peak in 2015, we think Rakuten is starting to look very attractive and should outperform the market in any further correction as it has more recently. We believe any change in its management or ownership structure involving Walmart or indeed Alibaba, or any strategic u-turn away from building a costly wireless network of its own in Japan or indeed raising its currently very low shareholder payout ratio, any of which could lead to a major re-rating in the name.