Difficult to see a sustained market rally given weak economic fundamentals and geopolitical uncertainties
As we highlighted last week, with stocks having had already staged a decent bounce on hopes for a positive outcome from US/China trade talks in the G20 summit, it was difficult to see stocks seeing a more prolonged rally given the economic fundamentals pointing to slower growth prospects and weaker earnings for next term. The idea that the Chinese will change their whole economic structure within the 90 days extension as has been initially demanded by some China hawks among key US policy makers seemed a bit farfetched at the time and even more so now.
The arrest of Huawei’s CFO, Meng Wangzhou in Canada on charges of conspiracy to defraud banks by using a subsidiary to do business with Iran has muddied the waters even more. China’s demand for her immediate release, calling the move “unreasonable, unconscionable and vile in nature”, indicates that this will probably not be dealt as a separate issue from the trade talks with the US which is seeking her extradition.
With US law makers on both sides of the isle looking unlikely to allow Huawei to be used as a bargaining chip like ZTE was a few months ago, Trump administration is in more awkwardly position to intervene to try to de-escalate trade tensions and regain control of the narrative. Moreover, the unilateral reinstatement of sanctions on Iran is what the US president had championed personally. Having already issued temporary wavers to key allies, allowing importing of oil from Iran, any further concessions here look to meet stiff resistance.
The Japanese government also followed through and effectively banned the use of ZTE and Huawei equipment by all Japanese government agencies. This will likely to have sent a strong message to all of Japan’s carriers to potentially follow government’s directive. We believe this could leave one of our top short sell picks, Softbank (9984) highly vulnerable as it is known to have used Chinese equipment suppliers for its network infrastructure.
We also wonder if China will retaliate and ban Japanese telecom equipment suppliers from its 5G market. If so then one of our other short sell picks, Anritsu (6754) could be impacted in the medium term and it will further reinforce our view that 5G testing market will prove to be much smaller for Anritsu than 4G was given that much of the upgrades will be software driven. Trading at 15x 3/22 forecasts, or 3 years out, we think its shares look rich having factored in much of the 5G capex growth with surprises looking more on the downside.
Going back to Softbank, the potential costs of replacing this equipment used for its network, including those utilised by its Sprint subsidiary could put more pressure on the group’s profitability which is already facing steep wireless tariff cuts in Japan for next term. With its unfortunately timed 4 hours network outage in Japan coming a day before its domestic telecom arm’s IPO pricing, we think Softbank Group is facing much scrutiny including the steep valuations of its IPO which has mainly targeted retail investors and its close association of its Vision Fund with the Saudi public money which may or may not be subject to future sanctions, partly depending on whether mass famine will be avoided in Yemen.
As we also underlined last week, we were looking to add some China-sensitive automation plays back to our short sell picks if their rebound continued. After last Monday’s rally fizzled out, we added Yaskawa Electric (6506) to our sell list. With its shares still trading close to 20x average next term’s earnings forecasts which we think look optimistic at this stage, we see at least 20% more downside from here.