17 February 2019

Japan's stock market has nicely absorbed much of the downward revisions in earnings for this season as investors remain glued to the direction of the US market which continues to dictate the path to higher levels. Although Topix has cleared its 50-day moving average, it is still trading below that crucial Y1600 resistance line which we believe it will ultimately clear in the shorter term. Meanwhile, S&P500 which is leading the way has broken out above its 200 day line and looks to be to heading towards the all important 2800 level which if cleared, leaves market bears in a very tough spot.

Once again geopolitics is setting the tone with US/China trade talks sounding increasingly positive ahead of the March deadline in further raising tariffs as senior Chinese delegate look to be heading to the US to further hammer out the differences on both sides. As we have consistently underlined from the start of this year, we continue to believe that with policy makers from both nations needing a deal to calm market anxieties that led to big declines in share prices last year, further tariff hikes on Chinese imports to the US will be avoided at all costs as the US side will push out the deadline further once more in order to buy more time to tackle more fundamental issues regarding China's economic structure and policies. 

With the US government shutdown also looking to be avoided as the Trump Administration is looking to fund the security wall through other emergency measures, another very important obstacle seems to have been cleared. Whether the government can pass this funding through or not does not seem as important and its outcome should not have a big impact on the stock market from here. 

With these two major issues looking to fade to the background for now, much now depends on the US Federal Reserve and its monetary policy which will be watched very carefully from here. With US retail sales for December proving surprisingly weak, we think it is more than likely that the US central bank will continue with its newly adopted dovish tone which has also gone a long way in easing market concerns about a potential policy mistake as the pace of normalisation looks to slow further. 

Indeed, the market this week will be combing through January's board meeting minutes with focus on the central bank's balance sheet and the pace of the unwinding of its $4trn bond holdings. Given the likely rise of Treasuries issuance this year to fund the US budget deficit and the tax cuts of last year, any easing on that front or any indications of halting the unwind operations at some stage this year could add more fuel to market's rally both in stocks and treasuries. 

For Japan, such a possibility would be particularly bullish for the stock market as it would further reduce upward pressure on the yen which depreciated further last week above the crucial Y110 against the dollar and above most corporate earnings budgets which have earmarked a ¥$ rate between 100 to 105 level. Although the direction of the Japanese currency has been overshadowed by other concerns in the past few months, further weakness in the Japanese unit could become a positive factor, especially if it can clear the 111.60 which would take it above some crucial moving average lines. 

Moving down to some of our favourite sectors, we retain our bullish stance both in semiconductor and factory automation plays which we believe will be seeing a gradual signs of demand recovery as their secular growth trends look intact despite the cyclical headwinds and geopolitical uncertainties which have impacted outlays. Following earlier comments we highlighted in our last week's publication by Microchip that the firm believes this quarter will see the bottoming of demand, we have since heard similar remarks made by management of Nvidia and Micron, both providing better visibility to a bottoming out scenario in the first half of this year. Indeed, our own channel checks and recent visits to key Japanese firms seem to also support this view--although the pace of recovery in automation tools could prove somewhat slower.