09 September 2018

Once again Topix dips towards the low end of its trading range for this year, nearing its key support line of ¥1670. With lower highs being posted after each bounce since May, we believe the possibility of a big correction is increasing, especially as US policy makers are turning increasingly hawkish towards America's key trading partners outside of NAFTA. EM's spreading currency contagion is another ongoing anxiety which we feel will not abate anytime soon given the tightening US monetary policies. 

With geopolitical risks reaching dangerous levels as disruption to global trade becomes a real possibility, we retain our generally negative stance towards Japan's stock market as we have done for much of this year. More specifically, our scenario for weaker semiconductor and factory automation trends which we have frequently written about in this publication is gradually transpiring. Although we recognise the secular growth trends that the market has been excited about in the past few years, we feel that the cyclical nature of these sectors has been overlooked and leaves more downside as there are plenty of stale bulls out there which we suspect will capitulate as we get closer to year-end. 

With trade routes looking to be redrawn, we feel that the increasing uncertainties are bound to curtail capital investment plans in factory automation and robotics segments. We also think that we are at an early stage of this capex pull-back which could prove deep should US trade barriers become higher. Although these headwinds are unlikely to have been notably felt yet in semiconductors, as we have also outlined previously the sector is facing its own demons. namely weaker end-demand and falling memory prices which have persisted all year. We are even hearing of foundries starting to see falling utilisation rates led by industrial chips which dominate 8" wafer lines.  

We urge readers to remain generally underweight Japanese techs, machinery and auto names which make up the majority of Japan's exports and its surplus. Moreover, although the yen has been relatively stable thus far, holding its own against the general trend for a stronger dollar against other currencies, the Japanese unit should become a safe haven again if sentiments worsen which could add more selling pressure on shares of exporters. The possibility of Japan being named a currency manipulator by the Trump administration is also a real and present danger. 

Although this week we have refrained from focusing on individual ideas, we have generally positioned our long/short picks based on the above scenario. Meanwhile, we have maintained our bullish outlook on Japan's top financial names which we believe are cheap, big beneficiaries of long term rates trending higher while also being highly insulated from the inevitable sell-off in JGBs thanks to the BOJ's oversized QE program buying much of their holdings and effectively bailing them out. 

We would also like to highlight that judging by Japanese firms' recent earnings trend, we think input costs are starting to be gradually passed down the supply chain and labour shortages are looking increasingly pronounced. We thus believe that inflationary pressures are brewing in Japan as they have been in the US and expect the BOJ to be forced to taper.