19 August 2018

The Japanese market continued to correct with Topix reaching near the bottom of its trading range for much of this year, as concerns about the peaking tech cycle, jitters about Chinese mobile games industry and general worries about emerging markets' debt led shares lower. Although indications for a "low level" trade negotiations between US and China has raised some hopes of an eventual resolution to the trade disputes, we believe our market will tread carefully now.

We firmly retain our negative stance on Japanese tech names while continuing to advise going long financials due to what we view as an inevitable steepening of the yield curve as BOJ looks increasingly pressured to abandon its inflation target. Nevertheless, we think inflationary pressures are brewing in any event as escalating costs related to Japan's acute shortages of labor and rising input costs are gradually being passed on within the supply chain.

Another reason for our general caution for yen-sensitive plays remains the Japanese currency. Although the yen  continues to trade in a band, we think any clear signals of BOJ tapering or  the central bank tolerating higher long term rates could lead to it strengthening back to key support levels of 105 against the greenback tested back in March.

In short, we think BOJ's eventual normalisation policy will prove divisive for Japanese stocks as the steeper yield curve which is generally positive for financial names leads to a stronger yen which will provide a major headwind for exporters. If we are right, we think a corresponding sector allocation will prove crucial for out-performing in Japan going forward.
It is also interesting to note here that the yen is already testing its May highs against both the Euro and the Korean Won and it is at its strongest level in 18 months versus the Chinese currency.

With both AMAT and Nvidia posting disappointing earnings results in the US, Japan's SPE shares came under more pressure justifying adding back Advantest (6857) to our suggested short sell list last week. In fact we remain pleased with the general performance of most of our short picks, including names we have outlined in this publication like Sumco (3436), Cyberagent (4751),Taiyo Yuden (6976), V Technology (7717) and Shiseido (4911).

One name which we remain very bullish about is Toray (3402) as we continue to believe it remains hugely undervalued relative to its underlying growth rate and the sheer quality of its business. Although higher input costs, goodwill charges and deteriorating product mix in its carbon fibre division had led to its huge derating, we Toray remains one of world's most important plays in the light-weighting trend that will play a key role in aerospace and automotive over the next 10 years. This along with its exclusive supply contracts with both Boeing and Uniqlo leaves us convinced that Toray is simply mis-priced here. To view our complete long/short list and our ideas updates, please contact us.