21 October 2018

Despite continued market jitters, Topix has managed to hold above its key support line of 1680 level which it had previously tested a few times this year. With Y$ rate leading the Japanese market, its recent rebound above 111 level has provided some relief as most corporate earnings forecasts are based around 105. 

With earnings season about to begin, investors seem cautiously optimistic that last quarter's results should be generally good. This may be so but we see dark cloud appearing on the earnings front that forex alone can't dispel, especially in key areas like semiconductors, passive components, machinery, machine tool and factory automation segments. So soon after grim numbers and outlook by the robot and servo motors specialist, Yaskawa (6506), we saw Harmonic Drive (6324) posting a whopping 58% drop in its Q2 orders. With Harmonic's small speed reducers dominating the global market in robotics, we believe this is another key lead indicator of what is to come. 

Indeed, even positive results and decent outlook from key bellwether names like ASML and LAM Research (LRCX) met with muted reactions and later with more selling. We suspect the market is starting to look even beyond next quarter and is becoming increasingly convinced of slower growth trends ahead as end-demand is starting to soften just as more capacities have come on line. Although we have slowly lowered the number of our short sell picks in the manufacturing segments in favour of some very overvalued defensive names where domestics have taken refuge in, we still retain some key short picks in our list such as Daifuku (6383), Sharp (6753), Advantest (6857) and Taiyo Yuden (6976). 

As mentioned in last week's publication, we are looking for earnings expectations to be revised lower going into H2 of the current fiscal year. We also view next term's analysts' earnings projections for Japanese manufacturers as generally too optimistic given the cyclical peak signals we are seeing now. We also suspect any strong earnings results within cyclical names will be generally ignored. So either way, we think earnings season will bring with it more selling pressure rather than providing a solid support for the market which many strategists had been hoping for not long ago. 

Given its importance, we would like to once again underline that we strongly believe BOJ is at a cusp of a major regime change in its monetary policy. With the central bank raising its price outlook and its chief, Kuroda-san most recently hinting of possibility that the bank could lower its inflation target while also declaring Japan to be at near full employment, we believe an official tapering and normalisation program is imminent. 

With the Fed's intention to tighten further looking very clear now and US policy makers reiterating their stance on currency stipulations in future bilateral trade agreements, time for BOJ's QE program looks to have simply run out. We thus, continue to urge investors adopt an over-weight stance in Japan's top banks and insurance firms as key beneficiaries of steepening of the yield curve. We suspect portfolio weightings in financials could prove a crucial factor in performance over the next two quarters.