We retain our negative stance on Japan’s stock market for now

We retain our negative stance on Japan’s stock market for now, remaining focused on what is happening in the US which more or less dictates sector moves across the Pacific. As we have argued for many weeks now, we think much of the stronger earnings results look to be priced in, especially in momentum stocks, namely tech names which have led the market up in the past few years. Thus far, this hunch has proved correct. 

With smartphone market clearly saturated and IoT unlikely to stimulate demand for leading edge technologies that have kept profit margins on a notable uptrend, the super-cycle scenario which would be needed to keep technology stocks’ earnings multiples on an uptrend is starting to look increasingly doubtful. Moreover, with NAND yields having said to be improving fast as supply of 64/72 layer 3D NAND is notably increasing, severe pricing pressure is negating much of bit growth in demand from solid state drives being increasingly utilised by Big Data. Although DRAM has faired much better thus far, DRAM prices have also peaked recently and together we think memory ICs will be looking to struggle to retain this level of profitability. 

With key tech names such as Facebook, Google, Amazon, Microsoft, Intel, Micron and Western Digital, all reporting relatively decent results, some of which did see a brief share price rally, they have struggled to hold on to their price gains. Moreover, we think regulatory scrutiny, especially in terms of data protection and privacy matters is likely to lead to much higher spending patterns going forward. One key set of earnings that will impact many Asian tech names is from Apple on May 2nd. With the US tech giant said to be severely struggling with its smartphone sales, it will be interesting to see how much of the bad news has been discounted here. 

To us it is clear the stock markets are increasingly focused on the bigger picture. Indeed, the macro environment is becoming increasingly negative with both short and longer term rates heading higher in the US while growth in Europe seems to be slowing, partly due to very poor weather conditions last quarter, particularly in the UK. Although easing geopolitical tensions have removed some uncertainties in the short term, especially as North Korea seems to have made a radical u-turn towards nuclear disarmament, it is interesting to see that some key US defence-related stocks such as Lockheed and Raytheon whose shares have been on a steep uptrend for the past decade, coming under severe selling pressure. After all, prospect of war, however unlikely, has hardly ever been bad news for stock markets. 

Moving back to Japan, the BOJ under the continued leadership of Kuroda-san whom has begun his new four year term has dropped its time horizon for its inflation target of 2% in an attempt to underline its patience in seeing its reflationary measures kick in. As we have argued, with input costs on a notable uptrend and labor shortages in Japan becoming an increasing problem across the industry, we think future inflationary pressures are highly skewed towards the upside and with BOJ’s heavy-handed QE operations having left the JGB market chronically illiquid, risk of big spikes in government bond yields cannot be dismissed. In short, we feel that Japan’s central bank has cornered itself into a very precarious situation which promises highly volatile capital markets once its tempering begins. 

Indeed, higher input costs are already being felt both in the US and are starting to show up in the early earnings numbers coming from Japanese corporates, raising concerns about peaking profit margins. With the oil price uptrend remaining firmly intact and the US likely to demand renegotiating the Iran nuclear deal by May 12th deadline, we expect this trend to continue. This is most likely to put further upward pressure on pump prices which president Trump has begun complaining about,  potentially putting pressure on OPEC to rethink their supply cut strategy which has been magnified by severe supply issues in Venezuela where lack of hard currency is having a devastating impact on its industry. 

Moving on to the currency, the dollar’s rebound against the yen continued as some market watchers seem to suggest that with the benchmark 10 year treasury bond yield breaking above 3% level for the first time in four years, overseas investors are becoming increasingly attracted to US government bonds. We are not so sure and despite heavy short covering of the Greenback in the past 3 weeks, we see the risk off mode in capital markets to once again dictate a rebound in the Japanese currency in May and expect the Y$ rate of 110 level to prove to be a solid resistance going forward. 

As far as our Japan stock picks are concerned we remain generally short tech names while we favour the financial sector as well as some heavily sold off industrials where prospects of restructuring is starting to look fairly promising. For those interested to view our recommended long/short list as well as our suggested pair trades, please contact us to be added to our 3 months trial service. We wish our readers a happy Golden Week.