31 March 2019

We have reached the one-year anniversary of this publication, a small milestone which marks twelve months of very eventful period characterised predominantly by geopolitical upheaval which had spilt into the real global economies, creating much uncertainties. With US policy makers reassessing their trade and defence policies, China becoming increasingly viewed as an economic powerhouse and an opponent to the West that needed to be put in check, the European Union looking increasingly fractured by rise of populism and Brexit, the post WW2 order has become severely strained. 

With central banks struggling to exit their massive and unprecedented QE stimulus programs post the financial crisis that gripped the world over a decade ago, markets have continued to grapple with government and private debt levels which have surged in era of ultra-loose monetary policies. With no past play-book to resort to, markets have remained highly cautious as we sail through these unchartered territories. 

 

Much of these issues continue to dominate the headlines today with US stock market leading the direction for the rest of the world. Indeed, domestic and economic issues in Japan have played very minor roles in driving Japan's stock market which continues to takes its cue from geopolitical and economic developments in both US and China, its two main trading partners. This scenario has kept us very busy with closely following the events unfolding outside of Japan. 

Having been negative for all of last year, we turned much more positive at the start of 2019, arguing that much of the bad news look to be factored into share prices by the end of December as the US Fed was turning increasingly dovish in its monetary policy stance while the trade tensions between US and China looked to be easing. However, last week we turned cautious again, concerned about what the inversion of the yield curve could mean and what the big rally in global bond markets were signalling. We advised investors to take profits in cyclicals and cover short positions in more overvalued defensive plays.

Thus far, the stock markets have been far more calmer than what we had feared and cyclical shares have started to recover from the previous week's big wobble which we had thought signalled a potential end to the big rally we have seen in the quarter, at least for the shorter term. Indeed, some warnings by US trade representatives that the US/China trade agreement could take longer than anticipated had also failed to dampen sentiments as the de-escalation of trade tensions seem to have been good enough for market participants to ignore the possible delay as a trade deal of some sort remain very much on the cards. 

For its part, China is said to be making great strides in meeting US demands for enforcing intellectual property rights, to provide greater freedom of foreign ownership in China-based ventures and allow increasing access of US tech giants to China's digital economy. Although one key sticking point seems to be China's demand in immediately removing US import tariffs on Chinese goods which has been met with resistance by the White House, we think the US could also concede to this or at least provide a deadline for removal of import duties if policy makers deem that enough progress has been made.

The above scenario could indicate that the adoption of our more cautious stance was perhaps not warranted and bond market participants could have become overtly negative by pushing bond yields too low and a potential correction which could reverse the yield curve inversion in the coming weeks. Indeed, signals of green shoots appearing in China is starting to emerge and key gauges in consumption and the region's manufacturing sector have started to show some signs of recovery last month.  

We shall wait for now as we enter the new quarter to see if the US market sentiment continues to improve and bond yields will start to edge back up. If so, we will not hesitate to re-adopt a more bullish stance in semiconductor and factory automation segments which we continue to view as the two most promising areas in Japanese equities as we see their secular growth trend being re-established sometime in the second half of this year.