A volatile week ended in a positive tone from trade talks
After much speculation about the direction of US/China trade talks that whipsawed the markets, with US blacklisting more Chinese firms and pondering curbing its public pension funds investments in listed Chinese entities that had dampened the mood earlier in the week, the actual trade talks resulted in a much more positive conclusion. In the US stock market, S&P finished the week back towards its previous week’s highs but off its session peak on Friday as some caution prevailed going into the weekend. Nevertheless, the volatility index fell back towards its September lows and the yen/dollar rate which as we explained last week has been a far better measure of global investors’ risk appetite surged back above 108 level and towards the highs of its past two months.
Japanese stocks resume outperformance; Great shorting opportunities in defensives
In or own market in Japan, Topix managed to outperform the broader market in the US last week, regaining some of its lost ground from the start of the month and building on its notable outperformance from the beginning of September from which time it has gained nearly 5.5% vs 1.5% rise by S&P. Indeed, our big shift to a bullish stance on Japan since late August has thus far proved fruitful and we expect this trend to continue. This is also underlined by what clearly looks to be investors’ sector allocation towards more cyclical and industrial areas, not to mention, the financials and at the expense of more defensive segments where the market participants had been seeking refuge for much of the past 20 months and where we consider them to be fertile grounds for fantastic shorting opportunities and alpha generation.
Improving sentiment on trade to derate significance of weaker earnings season
Last week’s moves further underlined the importance of a trade deal to markets as global economies are showing more notable signs of slowing as weakness in the manufacturing sector is now spilling over to services. This makes efforts in understanding the geopolitical shifts as worthwhile given that any perceived improvements in trade relationships between China and the US will once again derate the significance of the coming earnings season which will undoubtedly be pointing to a weaker corporate profit picture. In Japan, we have already seen early signs of this by a key bellwether name in factory automation space, Yaskawa (6506) which after having slashed its earnings outlook by as much as 60% was a met with a very muted share price reaction. We believe many other names with high percentage of shorts outstanding are likely to see a big squeeze as investors look for signs of orders bottoming out, as long as prospects for trade negotiations show continuing signs of improving.
More positive trade talks ahead but US congress must be watched carefully
Moving back to reading the tea leaves on trade issues, we think that by seeing China clearly drawing a fence around its industrial policies as a ‘no-go’ area in negotiations was very encouraging as the US side seems to have accepted the idea that state subsidies and China’s industrial policies are more a reflection of its political system that cannot possibly be altered as long as China is ruled by a communist system. However, with good inroads made on intellectual properties laws, majority ownership rights in US businesses doing business in China, large US agricultural goods purchases, opening China’s financial markets, curbing opiate exports and currency controls, we continue to see more positive sentiment emerging from future trade negotiations in the coming month. However, the key question now is whether the Trump administration will be allowed to make these unilateral deals and bypass the congress as the president has tweeted he would or will the House of Representatives try to derail any ultimate trade deal ahead of the presidential election next year.