Stock markets facing bubble trouble
US stock market indices continue to march higher led by a narrow band of big tech names that have propelled the rally ever since the bottom in March. Some observers are calling this a K-shaped market, characterised by a small number of winners going up and the rest of the broader market on the losing end. Indeed, with travel and leisure-related stocks which are highly sensitive proxy for how that market feels about the timing for an end to the pandemic continuing to languish after their brief rally which fizzled out in June, there doesn’t seem to be any major anticipation of an imminent vaccine-induced relief rally for the rest of the market.
With US bull market proxy names like Apple up another 30% and Tesla up by a further 40% in less than a month, it is getting increasingly difficult to see this trend ending well for market participants as we sense we are reaching a euphoric stage of the market, especially signalled by huge flow of speculative bets by US retail investors. Besides the bursting of the dot.com bubble in 2000, the situation today very much reminds us of our own market in Japan back in 1989, at its very late bull market stage when valuations had become more or less irrelevant and silly themes chased mainly by retail investors had helped push Nikkei to nearly 39,000 level, up by 30% in 12 months by the end of that year. Although every asset bubble has its own unique characteristic and it is impossible to speculate what could trigger such a reversal in sentiment, one thing they all have in common is that their bursting usually come when the last bear has thrown in the towel.
The fact that the current market rally in the US is being continuously led by such a narrow group of big tech names on one hand, and some smaller moon-shots chased aggressively by retail money on the other, and more notably, with short positions in stocks reportedly at a 16-year low, we think investors should be bracing for trouble ahead and move to more cyclical value plays which we now view as being more defensive as a strategy and wait for some more positive news to emerge on the vaccine front. With US Covid infections still on the rise and the coming colder temperatures unlikely to help matters, bankruptcies surging towards 2009 highs, fiscal relief measures seemingly paralysed ahead of the presidential election and geopolitical tensions with China looking dangerously elevated, we see nothing but red flags in the near term, especially for market leaders. This is certainly the case for Japan where stocks have not only been propped up by BOJ’s ETF purchases with no real end objective but other Japanese policy makers have done little to exhume much confidence in their approach to contain the virus or stabilise the economy.
Turning more negative on short-term outlook of Japan tech stocks
For all of this year up until two weeks ago, we had been bullish on Japanese technology stocks, arguing that during the pandemic, the sector which have clearly been seeing improving fundamentals provide a good shelter from the current global economic fallout. Given that Japan doesn’t really have any global champions like Apple, Netflix, Microsoft or Amazon, nor any cutting-edge semiconductor names like Nvidia, AMD or TSMC, our focus have been on semiconductor materials and production equipment names which Japanese firms still have a strong presence in.
However, we have dramatically shifted away from the sector in the past few weeks, becoming increasingly concerned about the oversupply of chips bound to data centres, weakening recovery of smartphone shipments in China and potential geopolitical disruptions from the latest US blanket ban of sales to Huawei, not to mention, repercussions of banning US firms from using WeChat. With semiconductor capex likely to start showing a weaker trend for the rest of this year led by retrenchment in memory chip investments, we believe the time has come to actually start shorting some of Japan’s much-loved semiconductor manufacturing equipment plays in the near term which have performed strongly from the start of 2019. With some of this year’s positive distortions of “stay at home/work from home” trends also like to fade, we see more reasons for caution in the short term and have dramatically changed the composition of our long/shorts accordingly.
The good news is that after much frantic corporate lobbying in the past few weeks, the Trump Administration seems to be back-peddling on banning Tencent’s WeChat, allowing Apple and other American companies continued access to the app in China after having realised that such a ban on the mainland will have dire consequences for Apple’s iPhone sales, not to mention, potentially impacting others like Starbucks which allow its customers to use the app for payments. However, this U-turn will no doubt give the Chinese government a glimpse of how dependent US firms are on WeChat and just as Google has been banned to provide Huawei’s smartphones with its Android OS, if pushed China too could ban Tencent from providing its WeChat app to Apple’s iOS, providing a big potential boost to sales of its homegrown smartphone firms in the domestic market. However, for now we think China will refrain from making such radical policy moves, in hope that potential change in the White House in November will lead to de-escalation of tensions.