23 September 2018

Markets were a in buoyant mood last week with US stock market indices hitting new highs and the weaker yen helping Japan's broader market recover to its May highs to test the top of its trading range of much of this year. With US market participants seemingly having made up their mind that trade tariffs on Chinese goods will not haver a significant impact on corporate earnings, at least not in the short term, investors have chased stocks higher. 

In Japan's market, what is most interesting is that sectors leading the rally have been more industrial and financial names, with technology and automation continuing to come under selling pressure. With more signs of activity slowdown appearing in the semiconductor segment with spot priced for both NAND and DRAM chips lurching ever lower, analysts are increasingly tweaking down their earnings projections and lowering their share price targets for memory-related names. 

With many of our short sell candidates coming from this segment we are seeing our shorts generating very decent alpha in a strong market. We retain names like Advantest (6857) high in our recommended shorts list. In the meantime, our strategy of remaining aggressively exposed to Japan's top financial names such as SMFG (8316) and Dai-Ichi (8750) have also contributed strongly to the outperformance of our long/shorts. 

As we have argued for weeks, with BOJ looking increasingly likely to allow longer term rates to head higher, we believe most financial names are likely to outperform strongly as overseas investors remain generally neutral or underweight these names while still many remain fairly exposed to Japan's top exporters. We think this forced re-allocation of sector weightings will have a pronounced impact on performance of Japan equity funds for the next quarter, particularly for those with long-only strategies. 

With the Fed looking to raise rates this week and the US economy looking red hot, it is difficult to make a case for any slowdown in monetary policy tightening. This is especially as prices are starting to move higher, and rising tariffs in imports is only likely to exert further upward pressure on prices of consumer goods. We thus expect a continued move in interest rates towards reversion of the US yield curve, adding more uncertainty regarding US financial conditions in the months ahead. 

For now, much of the market's attention will be on the bilateral trade talks between Japan and the US planned mid-week. With Japan like Mexico likely to yield to many of the US demands to try to avoid auto tariffs being imposed on its car makers, one would hope for a more favourable outcome than those talks US has had with China. However, whether the US president will adopt a more pragmatic approach in dealing with one of America's key allies in Asia Pacific is anyone's guess.