Asymmetric Weekly: A rocky start to 2022 but Japan still looking good as rates rise

Among a short list of 2022 potential developments which we outlined in our last weekly publication late last month (link above), we have argued for US long term rates to climb above 2% as economic recovery broadens. To be sure, we weren’t expecting US treasury yields to surge so quickly. But we think that inflationary forces in play which are exerting upward pressure on US wages and rents are becoming more embedded and we suspect that the Fed will need to move towards a more neutral monetary policy, more quickly and perhaps even by more than a quarter of a point at a time. We also think the likely cold war with China which could disrupt global trade should also prove inflationary as geopolitics fracture the globalised trade structure and its supply chain which had brought with it over two decades of low inflation. 

As we have also argued, higher US rates is a precondition for our scenario of more short-term upside for Japan’s broader market given its economic sensitive nature as it tends to outperform other majors when rates start to rise. The current recovery of auto output production should also prove very positive across many of Japan’s sectors. Valuations also look very compelling versus the US and other developed markets. Moreover, weaker yen should prove earnings supportive and we are hopeful that Topix will retest its September highs, led by value and deep cyclical segments. Meanwhile, richly valued growth stocks could continue to struggle leaving a fertile ground for near term shorting opportunities. It is also worth noting that Japan’s smaller cap names which are more growth-oriented have already seen a major sell-off since early December with Mothers Index down by nearly 20% since then. 

Another more obvious precondition to any short-term market gains and rising rates is the state of the pandemic and as we have noted from the earliest findings coming out of South Africa regarding Omicron, omens are good as more research papers continue to support the thesis that this, more contagious Covid variant is also a milder form of Covid with shorter incubation and infection periods. Thus, we suspect this wave will fizzle out as quickly as it has blown up, thanks to growing natural immunity in line with high infection rates and varied levels of defence from existing vaccines. There are also good reasons to hope that those infected by Omicron become more immune to reinfections including to the Delta variant, hopefully before Delta spawns a potentially more sinister mutation. 

Beyond this shorter-term scenario, the outlook for markets don’t seem too encouraging, as more liquidity is withdrawn from the system and bubbles in many asset classes look set to burst. Moreover, prospects for tighter export controls of capital goods to China which we view as inevitable, could have a more notable negative impact on Japanese firms’ order books. This is especially so in semiconductors space which Japan is a major supplier of materials and manufacturing equipment. 

We also think that as far as Japan’s market is concerned, our early poor assessment of Kishida-san’s government has not been too off the mark as proposals for higher capital gains tax, introducing guidelines for share buybacks, not to mention, pressuring firms to raise wages leave little room for potentially any major positives from Japan’s new government. Moreover, with closed border policy having won back much public support for the cabinet, Japan looks likely to be one of the last big economies to re-open for travel.