With US stocks leading other markets, we have kept a close eye on the developments there as Japan’s corporate earnings have proved far from encouraging to expect any sort of decoupling. Thus, for this week, we have focused our thoughts on the bigger picture stuff, especially on US political and economic policies which will play vital roles in determining next year’s market outlook.
Having seen US stocks bottom in the previous week, markets rallied for much of last week, celebrating the end of October and historically bullish month of November for stocks, especially during the years of US mid-term elections. Talks of big corporate share buy-backs, and strong US corporate earnings led the US and global markets higher. In Japan bombed out tech and machinery names predictably led the way up, especially as the yen continued with its depreciation against the dollar, testing the 114 level and inching towards that all important 115 resistance line.
However, the mood quickly soured again by the end of the week as the US Fed looked to be keeping on course for of another rate hike next month while inflationary measures like PPI and very tight employment conditions increasingly support the logic behind the normalisation of US monetary policy towards a more neutral stance. Rising concerns about a possible stagflation scenario leaves the October CPI data in the coming Wednesday as one key economic indicator to watch out for with average expectations looking for around 2.5% YoY increase. It will be interesting to see how quickly rising tariffs on Chinese goods will feed through to consumer prices or indeed if the higher costs will be absorbed by businesses.
Another concern creeping into the equation is the growing size of the US Treasury issuance as huge amount of public debt needs to be refinanced next year. Indeed, many prominent investors have started talking about the coming “supply problem” as talks of infrastructure spending on top of this year’s tax cuts are likely to lead to more issuance at an awkward time. Indeed, the Treasury Department has recently announced that it will be issuing a record $83bn quarterly refunding sales of long-dated paper. We believe this could also play a major role in pushing US long term rates higher next year, even as the underlying economic growth slows.
With corporate earnings outlook clearly showing signs of weakening, talks of peak earnings have also re-emerged. With mid-terms and most earnings results now out of the way, we think all eyes will shift back onto trade negotiations and whether the US will give some concessions to allow for a trade deal with China. Despite some earlier positive indications for a trade deal in the coming G20 summit at the end of this month, Peter Navarro, the White House trade advisor has lashed out on Wall Street executives who seem to have been pressuring the Trump Administration to sign a trade agreement with China. Navarro outlined that if there is a deal it will be on the president’s terms.
Here in Japan, corporate earnings outlook has undoubtedly dimmed as Chinese consumption and the sudden drop in capital outlays have left next term’s earnings forecasts by analysts as clearly too optimistic given the backdrop. Unless the US reverses course on trade, we see no other outcome but weaker earnings trends ahead. We also view BOJ’s lax monetary stance as very much behind the curve now given rising cost pressures and a very tight labour market, not mention QE’s distortions on Japan’s capital markets. Should the yen/dollar rate weaken further beyond that key 115 level, political pressures on BOJ to taper can only increase as US policy makers have said to be watching currency moves closely.