13 May 2018
We have seen a gradual improvement in market sentiment last week, particularly in the US which has been leading the direction in global markets. Market participants were seemingly looking for more reasons to buy stocks than to sell them. The North Korean peace talks for example have been seen as a positive while a much more dangerous situation brewing in the Middle East regarding the US pull-out from the Iran nuclear deal and the ensuing skirmishes between Israel and Iran in Syria have been largely ignored.
With the Fed choosing to hold off from another rate hike for now, participants also seem assured that inflation rate will remain in check and chances for any abrupt monetary policy tightening has lessened. Moreover, with big US treasury bond auctions last week having seen decent buying support, concerns over weak demand for government bonds at a time when the US budget deficit looks to expand dramatically have lessened. With the yield spread between 5 and 30 year Treasuries having narrowed to less than 30bps, growing prospects for an inverted US yield curve have also been largely ignored.
Despite these easing anxieties seen last week, we think none of the above headwinds have disappeared and expect these issues to return to the spotlight. Moreover, with US unemployment rate at less than 4% and now at its lowest level since the 1960s and the Bureau of Labor Statistics reporting that there were 6.5 million unfilled jobs in the U.S., the most on record, we think growing labour shortages combined with higher input costs will either eat into record corporate profit margins or will be passed on to the consumer. Neither of these possibilities seem very positive.
Rising input costs are also expected to eat in Japanese corporate profit margins as underlined by their recently released earnings outlook. Indeed, in Japan, given its fast ageing demographics profile, labour shortages look to become a much bigger issue as the economic recovery has exposed misguided immigration policies of the past which is finally being addressed now but looks to be coming too late to greatly help labour shortage bottlenecks appearing across the industry.
Although peace talks with North Korea is indeed positive for the whole Asia Pacific region, it has also weakened the position of Japan's PM, Shinzo Abe whose hawkish political stance briefly led to a resurgence in his popularity last year which he took full advantage of by shrewdly calling for a snap election. However, given that he has played no major part in bringing the North Koreans to the negotiation table, and domestic scandals have once again rocked his popularity which is now at record lows, any concrete peace agreement should further weaken his position within the LDP and could end his quest for constitutional reform which has been the cornerstone of his policy objectives.
We believe much of the recovery in Japan's economy since 2012 has been led by improving external factors as well as BOJ's heavy-handed QE programs which have helped raised asset prices and have kept a lid on yen's strength. Nevertheless, the growing possibility of an end to Abe's reign and his Abenomics agenda could raise market uncertainties about a lack of political leadership in Japan and worries about a step back to the rudderless days of the past two decades.
To be sure, we continue to view Japan as one of the most attractive stock markets with great prospects for higher shareholder returns through dividend hikes and share buy-backs while corporate management reforms are really starting to take route. Having bottomed near the end of March, closely following the Y$ rate, Topix has broken above its 50 day moving average last week and is looking to test the bearish window formed in early Feb. However, to see further gains, much depends on the direction of the Y$ rate which looks to have double-topped just below 110 level.
As far as our Japan stock picks are concerned we remain generally short tech names while we favour the financial sector as well as some heavily sold off industrials where prospects of restructuring is starting to look fairly promising. For those interested to view our recommended long/short list as well as our suggested pair trades, please contact us to be added to our 3 months trial service.