12 January 2019

It has been a good start to 2019, especially for our short sell picks among the more defensive names in Japan, many having been rerated to unsustainable valuation levels as safe havens in otherwise very challenging 2018. With Japan stocks closely following US equity markets, Topix has bounced by close to 10%, squeezing short position in the more cyclical segments of the market, especially tech names which we mostly removed from our shorts sell picks by end of last year. 

Although downward direction of earnings forecasts for 3/20 term has become much clearer to market participants, it has also provided some visibility to how bad things are and how much worse can it get. With analysts generally looking way behind the curve in downgrading their earnings forecast and ratings, we now suspect they are likely to face a market a whip-lash. Indeed, looking at valuations of many cyclicals, even assuming a 30% drop below average estimates for next term and a second half bottoming of earnings, some names are starting to look very attractive. 

Moreover, we continue to think that geopolitics will remain relevant for market's direction for now and we urge bottom-up investors to remain vigilant of global events. We think the US stock market plunge last year has clearly forced the hands of both the Fed and the US president, pushing for a much more gradual monetary policy normalisation and a more moderate approach to trade negotiations with China. 

In the case of a more accommodative US trade stance, this policy change seems less of an error as it might look for the Fed. That's because with China's economy also slowing, higher tariffs threaten to further weaken its exports. Thus, the Chinese policy makers have much to gain to also strike a deal. 

In fairness, the US trade strategy seems to have worked reasonably well as China is opening its markets in areas like financials, LNG, agriculture, movies, and autos. From a US political land scape point of view, these would seemingly satisfy most major lobby groups in the US. More predictably, in need of a deal, especially given the dragging of the US government shutdown, Mr Trump seems to have put his China hawk policy advisors back in their box for now.   

So trade issues could fade into the background later this year as both sides make some compromises and keep the optics as positive as possible. The market's conclusion in the shorter term would probably be that this should theoretically help gradually bring back the capex plans in China which have been shelved due to trade uncertainties. This would we think also means that weak factory automation-related data and earnings will be generally ignored from here in anticipating a second half improvement in activity.

Although Fed's reassurances that it is watching markets carefully has notably eased concerns about policy errors, any recovery in activity could only put Mr Powell back on course to normalise. So the pace of the Fed's monetary tightening seems less clear given the Fed chairman's firm beliefs in longer term normalisation to moderate asset price inflation. We see many similarities between Powell's resolve on this quest and those of the late BOJ governor (of the early 90s), Yasushi Mieno who believed that asset price bubble could destabilise Japan's society. 

For now, however, we suspect that market's bounce will continue as stock prices are no longer reacting to big downward revisions we have seen in earnings in the past week. We think is potentially a good omen going into the earnings season at the end of this month. We also think that 2019 could prove to be a great year for more nimble L/S stock pickers, not in only Japan but most stock markets globally. On behalf of all of Asymmetric Advisors team, we like to take this opportunity to wish our readers a prosperous new year and a good start to the new quarter.