14 October 2018

With most eyes glued to the ailing US stock market, this week we will look more at our own market in Japan and most recent indications which keep us cautious about earnings outlook. Although the yen has been trading at favourable levels for multinationals and domestic economic conditions remain fairly encouraging, the external headwinds seem to be only intensifying, especially those from China which has been a huge source of growth for Japanese firms in the past decade. 

Topix fell back to its lower range of its trading band last week following the big market sell off in the US, led by technology names. In Japan, however, tech stocks, especially semiconductor and automation names have been under selling pressure for much of this year and have been fertile ground for finding short sell ideas. Moreover, with domestic stocks generally holding steady, and cyclicals have already been beaten up, we think Japan should outperform other major stock markets, on the way down. 

Nevertheless, we are looking for earnings expectations to be revised down going into H2 of the current fiscal year. We also view next term's earnings projections for Japanese corporations as generally too optimistic given the cyclical peak signals we are seeing, at least in the shorter term. We particularly see Japanese B2B and B2C firms with extensive exposure to China toning down their short and medium-term growth prospects.

Last week, we saw the start of some earnings releases with the most notable being Yaskawa (6506), one of Japan's top factory automation plays. The firm fell notably short of market's already lowered earnings expectations. Orders were said to have started declining as slowing Chinese economy and saturated cell phone markets have become major headwinds. We see this trend being played out across many names we follow, particularly for one of our top shorts, Daifuku (6383) which has also big exposure to semiconductor production equipment which we remain very negative on for now.


China's so called consumption downgrade, broadly seen amongst its 400mn strong middle class is also looking to get worse before it get better, especially given tightening financial conditions for these households. With China looking to crack down on travellers importing luxury goods to the country without declaring these purchases, we continue to see weaker consumption trends ahead in the luxury segment with another our short picks, Shiseido (4911) looking highly exposed to and notably overvalued. 

For months we have raised our concerns about climbing input costs and severe labor shortages which are not only eating into Japanese corporate profit margins, but are also looking increasingly likely to be passed on. Interestingly, US firms are seeing similar trends which have kept the Fed on its monetary tightening path. With Japanese unemployment also at record lows, and the recent Tanakan survey showing corporate inflationary expectations climbing, we think BOJ is looking increasingly and dangerously behind the curve in its normalisation process.

BOJ governor's latest interview in the G20 summit, once again hinted of the central bank looking to taper its oversized QE program which has become increasingly criticised by Japan's top financial firms, pension funds, savers associations and more recently politicians. In reality, with a big wave of maturities, there simply has not been enough JGBs to buy to come anywhere near its QE targets without pushing rates to negative levels again. Interestingly, later this month the BOJ will be publishing its findings for negative side-effects of its ZIRP on Japan's capital markets. 

As we have argued, BOJ's super accommodative monetary stance is also becoming a political burden as US policy makers are increasingly hawkish about economic policies that leads to more competitive exchange rates. This was clearly expressed by US Treasury Secretary, Steven Mnuchin in the latest G20 talks, outlining that currency stipulations will be a key feature in future trade talks with China and Japan. 

Kuroda-san has for the first time declared Japan as being close to full employment and also strongly hinted of a possibility that the central bank could lower its inflation target to allow for the tapering to officially begin. This is a very significant signal we think. With much of the tapering thus far occurring in the long-end, we think further steepening of the yield-curve is inevitable. We see this scenario as being highly positive for the financial segments, namely for Japan's banks and insurers.