28 October 2018

With TOPIX following other global stock market indices down and gapping below its Y1650 support and the bottom of its trading range all year, it is now approaching that crucial 100 week moving average support line which was it only tested once since the Abenomics bull market began in 2012. With US market's focus shifting to the likely deterioration in earnings for next term, and rates heading higher for now, good results are being understandably ignored while those that undershoot high expectations get pummelled. We are going to keep this weekly edition short and sweet and focus on some individual names ahead of their earnings. 

As mentioned last week, we have retained some key short sell picks in technology space like Advantest (6857) and Daifuku (6383) but our general strategy is to steadily reduce these tech names and move our short picks into more overvalued defensives which have done far better this year and trade at rich valuations. These include Shiseido (4911) and our top pick, Cyberagent (4751) which we think could halve in value following what could only be described as very poor earnings results and weak forecasts for its new term.  

We think big market favourites such as Sony (6758) also looks vulnerable given the high earnings expectations. To be sure, we continue to very much like its gaming network's potential to substantially raise its profit margins in the medium term. However, with so many buy ratings and almost all sell-side bulls having raised their earnings targets for this term and next, we fear that general slowdown and PE compression could also hit this name which is still up 15% YTD, hugely outperforming both its sector and TOPIX. Having removed from our recommended longs in early October, we are looking to add Sony back should the name fall below Y5K after its earnings results this week.

Another market favourite releasing its earnings this week is Nintendo (7974) which we think looks far more vulnerable to a major derating than Sony is and we suspect the market will be  more underwhelmed by its earnings growth given high expectations by analysts looking priced into its rich valuations. However, in the case of Ninty, we also strongly believe any medium-term sales targets for Switch to go much beyond the instalment base of its ageing 3DS console of 72mn will prove too optimistic as we can't see Switch expanding Nintendo's fan base beyond those numbers given the competition from mobile games and other consoles. We also see Ninty's network strategy as being years behind that of Sony or indeed Microsoft. 

Although we have number of interesting longs which are outperforming the market's recent declines, and mainly because they are already oversold, our core strategy is to recommend aggressively overweighting Japan's top financials names which could stage a substantial outperformance as BOJ tilts further towards tapering. These are very liquid banks and insurers which we think are dead cheap, trading at big discounts to their book and yielding above 3% dividend. We believe we will be seeing a nice tail wind in the macro picture as BOJ move towards normalisation and steeping of Japan's yield curve which should improve their slim returns they have endured since BOJ's QE program crushed lending margins and fixed income investment returns.

How the yen will react once BOJ lowers its inflation target and officially tapers is a riddle we have yet to solve. Nevertheless, we must try as it remains a major factor in direction of the stock market. We believe logic dictates that yen should strengthen against the dollar. However, even during extreme market stresses such as one we have seen lately, the yen has remained relatively weak at Y112 to the dollar. Has the Japanese unit lost its safe haven quality? Given the geopolitical turmoil and the sheer size of Japanese money, we still think it would premature to write off 100 level over the next 12 months. Much depends on BOJ which we strongly believe is dangerously behind the curve in its normalisation program. To view all our Japan equity ideas, please contact us through our website.