14 April 2019

With US stocks generally heading higher, led by S&P which has broken above its 2900 resistance line, Japan's stock market has been cautiously held up with Topix just about managing to hold above its key 1600 support line as we move into the earnings season which everyone knows is unlikely to provide much cheer given the weak economic backdrop. 

Nevertheless, many bears have been squeezed out of their short positions in cyclical names as market is looking for improved economic conditions in China and easing trade and interest rate policy concerns that had clearly spilt into the real global economies. With technology names leading the way as reflected by SOX hitting yet another all-time high last week, bearish analysts look lost with their downgrades having little impact on share prices.

Indeed, investors have continued to shrug off these very late sell calls, confident as we are that the secular growth trend in the sheer pace of data generation will lead the recovery in chip demand and remain fully intact in the medium term. Moreover, recent guidance by the likes of Yaskawa (6506) also support our view that although factory automation and robotics demand remains weak, that growth trend is also likely to remain intact in the medium term as improving factory efficiencies will be unavoidable given the structural shortages of skilled labour, particularly in China. 

However, there is no doubt that dark clouds are gathering elsewhere and as US/China trade talks come to some sort of resolution, trade wars elsewhere are about to be waged. With bilateral trade talks between US and Japan to begin in Washington this week, we believe the Japanese capital market participants will be highly focused on developments there. 

Thus far, there are signs of a contentious early talks in the works as Japanese policy makers seem to have already set boundaries declaring that agriculture, auto export quotas and foreign exchange provisions are off the table. However, we believe US trade negotiators are unlikely to find these parameters as acceptable. 

Indeed, US Agriculture Secretary, Sonny Perdue had already expressed his hopes that Tokyo will yield to some sort of temporary trade agreement, setting provisions to lower Japan's agricultural tariffs as soon as possible and then hash out the details over time. With US having already pulled out of the Trans-Pacific Partnership trade pact, trade representatives are most likely be looking for independent pledges from Japan on this issue which will put the Japan PM, Abe and his LDP ruling party in a very awkward position.

We suspect the issue of auto imports to the US will be dealt with separately as we are still awaiting the publication of the findings of a report issued for the White House by the US Commerce Department in determining whether imports of auto and auto parts do represent a national security threat. If the findings do find this to be the case then it is likely that European, Korean and Japanese car makers will all be coming under pressure at the same time to increase their local production in the US and source more parts from within the NAFTA region. We expect the US to impose tariffs of at least 10% on imports and use that as leverage to gain more concessions. 

This leaves the immediate bilateral trade talks with Japan centred around one the most contentious issues of all and that is foreign currency provisions which if forced upon Japan could have a dramatic impact on its central bank's monetary policy. As we explained in last week's publication, the US could very well deem Japan's monetary policy as solely designed to depreciate its currency even if there has not been any direct forex intervention to keep the Japanese exports more competitively priced. 

In such a scenario, the external political pressure on the BOJ chief, Kuroda-san to ease off on the bank's ultra-loose monetary policy could intensify as it has done so internally. As we have argued, with 60% of Corporate Japan having very little debt and the industry remaining fairly deleveraged, BOJ's QE has not only failed to provide notable benefits for corporations but given that it has compressed lending margins, it has also unintentionally forced the banks to become less accommodative in their lending stance. 

The failure of BOJ's unorthodox monetary policy in creating rising inflationary expectations have been increasingly linked to Japan's fast ageing demographics which as the latest numbers show has led to further decline of over 260,000 in the population by late last year,  and the resultant chronic labour shortages have yet to lead to any upward momentum in wage pressure. With low rates having hurt Japan's savers, pensioners and returns on insurance policies that have led to higher premiums, Japan's central bank is under increasing pressure from all sides to abandon its failed experiment and allow long term rates to find their own natural level higher up.