Despite our short term optimism geopolitical risks remain elevated

Japanese stocks continued to rebound, with Topix having recovered by 10% from its late December lows. It has been an encouraging week in some ways as TSMC’s (2330) poor earnings was met with a muted response as hopes for a second half recovery left its shares down by less than 1%. Indeed, the fact that the Taiwanese chip giant has set its capex budget at relatively high levels provided more reasons to buy semiconductor names and related tool makers which we have turned bullish on at the start of this year. 

In our own market, Nidec’s (6594) big downward revision in its full term forecasts was also met with strong buying support with its shares closing just over 1% lower after having recovered most of its big intraday losses on Friday. Talks of Nidec seeing a very sudden slowdown in November and December when trade war was looking more likely failed to dent confidence in bargain hunting this quality name. We think all this bodes well for some oversold quality names, especially factory automation and semiconductor stocks ahead of the coming quarterly earnings season starting soon. 

One bombed out name which we like to address this week is Renesas (6723). We think the market is likely to also ignore its coming weaker earnings which is why we have added it to our recommended longs earlier this month. We think this name has a decent upside potential given its big exposure in auto-related semiconductors, more importantly chips for EVs and semiautonomous vehicles with Toyota (7203) its largest customer. With market shares in auto-related chips not much lower than that of NXP (NXPI), Renesas which is almost a third of the value of its US peer looks intuitively cheap. 

Given Qualcomm’s recent attempt to acquire NXP, eventually giving up after much delay in approval from the Chinese authorities, we think Renesas could be one alternative M&A target. It is interesting to point out that Nidec was also looking to buy Renesas back in 2016 but Toyota didn’t seem to support the idea. We also suspect the state-owned and ailing Innovation Network Corp of Japan which still owns 33% of Renesas will now be very happy to offload this stake which like its holdings in Elpida (now part of Micron) and Japan Display (6724), has incurred huge losses. 

Looking at the bigger picture, despite our short term optimism for stocks, geopolitical risks remain fairly elevated which could trigger another big stock market correction. Although fears of a trade war between US and China has receded and a noise of a potential policy mistake by the US Federal Reserve have faded into the background, the consequences of a prolonged US government shutdown is very concerning as the ripple effects could cascade to something much nastier. Once again we could find ourselves in an unprecedented scenario with no written play-book. 

Moreover, as far as renewed optimism about trade talks are concerned, we are not out of the woods yet as talks of a blanket ban by the US regulators on use of all Chinese telecommunication equipment suppliers could once again harden the Chinese stance. However for now, it is still safe to assume that both sides need some sort of resolution to reverse the disruptions we are clearly seeing on capital spending and investments.