15 July 2018

With indications that the US is willing to engage in trade talks with China shortly after threats of more tariffs by the US president, the market has staged relief rally as investors like to believe that the two sides will avoid the path of mutual damage. President Trump's strong push in the congress to lift the US ban on China's telecommunication firm, ZTE which he himself spearheaded in the first place, supports the rising possibility that he will be using this move to bring China back to negotiation tables to win more trade concessions in return. As we mentioned last week, China's response has thus far been very measured, careful not to fan the flames, further helping to reduce market's anxiety.

Also nothing new emerged from the NATO summit as the US demand for higher contribution by member states for the defence budget was as expected and despite some noise of extracting US defence personnel from key parts of Europe, the US president eventually put some minds at ease by underlining the US commitment to NATO. Nevertheless, his final departing comments forced an emergency meeting between member states to basically reassure each other that they remain fully committed to the security treaty.

However, the US commitment to NATO is likely be tested this week in the closely watched US/Russia summit, especially to clarify the US stance on Ukraine. Some political analysts have suggested that under pressure by its two key Middle Eastern allies, Israel and Saudi Arabia, the US president might be looking to offer to remove some of the US sanctions on Russia in exchange for them to leave Syria.

Any such offer or simply by ignoring the Ukraine issue could lead to bigger rifts in the Western alliance, especially with Britain where Mr. Trump's latest visit there did not help matters. On the other hand, the fact that 12 Russians military intelligence officers have just been indicted by the US special counsel for meddling in the 2016 US elections leaves the timing of the meeting between the two head of states as controversial and could leave the president with limited scope for any concessions.

Moving back to Japan, the yen's latest round of weakening against the greenback has also led to a rebound in shares of Japanese exporters as the unit has defied our expectations of remaining relatively strong as a safe haven currency, especially tested during periods of more weaker market sentiment in the past few weeks when the yen has not appreciated as one would have expected. Having now broken above a key resistance level of 112, any more weakness against the dollar in the week ahead could further improve Japan's stock market sentiment, at least in the shorter term.

Last week's relief rally also overshadowed recent concerns of slower order trends in the tech sector, especially from the Semicon West conference staged last week where participants have underlined slowing activity in the semiconductor sector and deteriorating earnings visibility. We are also seeing pronounced order declines from some key firms which we view as lead indicators in the high precision component segments of Japan, pointing to steep YoY drops in orders for factory automation, semiconductor and flat panel manufacturing equipments.

These issues keep us fundamentally negative on the tech segment despite signals for easing trade tensions and the weakening yen helping short term sentiment. We thus view any further rebound as attractive entry points for some of our key related short sell picks. For now, however, we suggest generally curtailing short positions until the likely resumption of trade talks is fully digested.

Last week we saw significant moves in both Rakuten (4755) and Softbank (9984), both of which we have recently added to our selected long picks. Although talks of Walmart wanting to exit Japan and looking to sell its Seiyu supermarket chain (which the firm has denied) does dim the prospects of forging a closer ties with Rakuten, we think there are other suitors out there for its e-commerce and its online financial platforms which are generating ample profits and cashflow. Come what may, we think pressure is mounting on the Rakuten management to raise shareholder payout ratio having seen the firm's share price fall by 70% since its peak in 2015.

Softbank's outperformance over the past month had already become notable as highlighted in our more recent weeklies. However, it was the news that Tiger Global fund has built a whopping $1bn stake in Softy that led to more significant gains, pushing its share prive above key resistance lines that leaves Y10k as the last of the major hurdles. We see more significant share price gains to come if Sprint/T Mobile merger is approved as we expect, and Softbank continues with its aggressively deleveraging and transferring some of its large holdings to its Vision Fund.

Another of our long picks which has performed well is Sony (6758) as there are not many Japanese tech names in Sony's size which are hitting new highs. It could very well be that the big re-rating of its gaming network which we have long hoped for has finally begun. With Sony's gaming network having over 80mn total active subscribers and seeing revenues surpassing ¥1trn last term, we think its operating margin could surge towards 20% as network expansion costs drop off, especially if Sony new game chief, Kodera-san cuts his losses and close PSN's generic TV channel offerings.