03 February 2019

Although US market rally looks to be broadening, Japan's stock market stalled somewhat as generally weaker earnings provided some headwinds in the short term as investors struggled to digest the sudden demand pull in the last three months of last year that many manufacturers have been pointing to. Nevertheless, we believe US stocks will continue to lead global markets higher and we look for Topix to trade above its key 50 day moving average this week, for the first time since early October, having been testing it for much of last week and advance towards its critical Y1600 resistance line. 

As we noted last week, with the US government shutdown having ended, at least temporarily, one major negative development had been averted. Moreover, we are also relieved to see that the US/Chinese trade talks are progressing as smoothly as we had hoped with growing global ban on Huawei's telecommunication equipment by 4G and 5G network operators have been ring-fenced by Chinese policy makers as a separate problem to trade issues. 

Come what may, we think the market has now largely priced in the likely scenario of US not raising tariffs on Chinese goods to 25% in March, possibly postponing the deadline towards September in order to allow more time for Chinese to make more progress on other more structural changes that the US hawks have been demanding. Although it would be naive to expect capital expenditure in Asia to rebound drastically in the short term, given that much of the pull back in capital outlays were led by geopolitical concerns, we see a scenario of a gradual recovery in spending plans which will prove positive for related stocks. 

As far as Japanese stocks are concerned the recent weakness in the Japanese yen despite a more dovish Fed is also another positive development which we think should prove highly supportive for the manufacturing sector. We thus, retain our generally bullish stance on factory automation and semiconductor-related names where we believe have more upside despite their moves since early January when we dramatically changed our outlook towards a more positive posture. 

For long/short funds, our recommended short selling strategy remains focused on identifying over-valued defensive/domestic names which we believe will continue to drastically under-perform the boarder market as cyclicals rebound. We have added a few more short picks from these segments with satisfactory performance thus far. 

As we pass the earnings season, we expect the market to switch back to a more macro-focused approach as it has been the case in the past few years. However, next earnings season is likely to prove far more important to determine whether the second half recovery that so many firms are talking about and are hoping for starts to show up in second derivative measurements in corporate orders intakes and quarterly top-line performance. Until then, we think we are in the clear for more stock market upside.