22 December 2018
This will be our last weekly publication for 2018 and we at Asymmetric Advisors wish our readers happy holidays and a prosperous 2019. Now back to business:
Japan's stock market continued to follow the US indices lower, officially entering bear market territory with Topix falling below its 200-month moving average for the first time since 2012 when the Abenomics rally kicked off. The Nikkei 225 on the other hand continued to hold its ground above its 200-month line as BOJ's ETF purchases based on the index continued to distort certain segment of the market which we believe has created big shorting opportunities.
Seven years have passed since anyone has mentioned 'bear markets' in Japan. For those of us who have lived through 20 years of Japanese bear trend, the only positive one can take away now is that this time the downturn has not been domestic-led. At least not yet! Nevertheless, Japan's equity markets remain highly cyclical and global economic cycles have obviously turned down.
Judging by our own recent company visits, the slowdown in activity is gradually moving beyond technology and automation and broadening in nature. Moreover, with the government sounding resolute in raising consumption tax next October, we think domestic-related stocks could also face selling pressure should consumption take a hit as it has done after past VAT hikes.
As we have outlined for much of this year, we think geopolitics will continue to play a key role in dictating market trends and this looks to continue to be the case going into 2019. Like it or not, investors need to stay tuned given the current unpredictability of US foreign policy and the political turmoil looking likely ahead.
Indeed, trade uncertainties have already dented confidence levels and capital outlays in Asia are clearly heading lower. Reading the tea leaves by looking at the most recent related events since the G20 meeting, it looks improbable that a trade deal between US and China will be reached in the 90 days deadline unless US policy makers back off from their bold demands.
The arrest of Huawei's CFO in Canada has greatly complicated matters. Moreover, with the US most recently accusing the Chinese of industrial espionage in its tech sector, targeting US corporations and its government agencies, we feel that President Trump seems to have lost some control of the trade narrative as most US lawmakers on either side of the isle now want action.
With January's US Congress shifting to a Democratic majority that look to spark many investigations concerning the president and his circles, on top of the coming Mueller report that is said to be reaching its conclusion, the Trump administration's political clout within the two political chambers look likely to be diminishing. In that situation, it is impossible to predict how the market will react and whether the US president adopts a more hawkish view and lash out or yield to economic forces in play.
At least one of his trade advisors and a China hawk, Peter Navarro most recently told Nikkei, to state the obvious, that any deal that tackles the fundamental shape of China's economy is unlikely to be reached within 90 days. Issues he outlined include forced technology transfers, cyber intrusions, state-direct investments, tariff and non-tariff barriers. These are some big issues that look to take years to sort out if indeed China wants to tackle them.
With China detaining more Canadian nationals in a response to the arrest of Huawei's chief, and China's president, Xi Jinping making a speech in the National People's Congress that the nation's domestic economic policies will never be dictated to by outsiders, clearly there will be no major concessions on that front. Nevertheless, we think we will see a watered-down version of a trade deal which both sides will agree with, mainly for optics as neither side can afford a full-on trade war at this stage.
Since the G20 meeting China has reportedly dramatically increased its imports from the US and looks to be opening its market to Hollywood movies, US autos, agriculture and energy. Come what may, with worries about slowing US economy pushing down share prices which the US president sees as a gauge of his economic success, we think the planned US tariff hikes to 25% after the 90-day deadline looks increasingly unlikely.
Moving to growing anxieties about possible Fed policy mistakes, it does seem that the central bank is unlikely to shift away from its policy goal of monetary policy normalisation. Talks of the US president considering firing the chairman has also become a major risk that markets can do without.
This is especially so given that even the reassuring words from Fed's NY chief, John Williams on CNBC that nothing is off the table in keeping the economy on its steady growth path (not even the halting of Fed's balance sheet shrinkage program should it be warranted) failed to lift market sentiment for long, last Friday. Thus, firing Powell could do even more damage to sentiment at this stage.
Given that there really is no playbook for most of these issues, there is no point in irresponsibly guessing the timing of the market bottom and risk a poor start to 2019. We thus urge investors to retain a high cash weighting for now and for L/S funds, a net-short stance which many still seem to be struggling with in implementing.
To be sure, from a bottom-up perspective, Japanese stocks continue to look attractive in terms valuations, technology, balance sheets, consolidation and restructuring potential and the growing consensus in improving shareholder returns. But these are known knowns and these days markets tend to act bottom-up for two weeks a quarter when earnings are released and go back to their macro default mode.
Nevertheless, over the past two months, we have increasingly shifted our short sell calls away from the deep cyclicals and technology segments towards more domestic/defensive names which have been drastically re-rated to seemingly unsustainable valuation levels and at this stage look equally exposed to the broader selling which we are starting to see most recently. In terms of alpha generation, we much rather be short these names in a market bounce than say go long high beta cyclicals and risk catching many falling knives as its impossible to tell how much of the coming weaker earnings have been priced in. For more information on our long/short ideas please contact us through our website.