Bombed out value names starting to shine while geopolitical tension seem to be more noise

‘Dash for trash’ sparks a potential change in market leaders
Rightly or wrongly, we have seen a notable shift in buying interest from technology names which had viewed as defensive and have massively outperformed this year, to more bombed out cyclicals and industrial value stocks on hopes of their recovery prospects. Certainly, there is little doubt that this quarter will prove to be the absolute bottom for many firms this year and gradual earnings recovery, however anaemic, looks to be on the cards from here in the second half. 

This shift in market perception has prompted us to also act, removing some of our best performing technology-related names in Japan which we feel have largely factored in this year’s growth prospects and have raised our exposure to more bombed out trash which are either within our ongoing themes or have some short term recovery prospects or are backed by a good emerging growth story down the road. Given the huge amount of money parked on the sidelines, reflected on the AUM of US money markets funds, now totalling record highs of over $4.7trn, we suspect this broadening of the market rally could prove a very powerful leg in the short-term. We also suspect this rally could also provide us with one of the most exciting short selling opportunities of the decade, sometime before the year-end. 

As noted in our 9th of May publication, we had already removed most of our bombed-out cyclical/industrial names from our short sell list. However, last week we removed the remaining names and are replacing these with individual picks that have posted a big recent rebound in their share prices which we feel have run way ahead of their earnings recovery potential, and look to at least under-perform a rising market.  Some of our current short picks come from the leisure industry which have bounced strongly on anticipation of an end to Japan’s lockdown which began last week, some are those which have seen a positive distortion from the lockdowns themselves like video games and some are just mainly overvalued defensive plays that should underperform a rising market. 

Anti-China drum beats getting louder but threats seem hollow 
Although the political strategy of blaming China for the pandemic in the run-up to the US presidential election remains fully in force as we had expected, one senses that as US states come of out of their lock-down phase, public attention is shifting to more domestic issues that could be rendering this political ploy less effective. Indeed, after President Trump’s numerous warnings of potentially imposing sanctions on China following its passage of the HK security law last week, not to mention, the issue of muslim internment camps in Xinjiang, Friday’s announcement by the US president lacked any specific economic measures that the market had been fearing. 

It should also be noted that the potential for removal of HK from the US special trade status could only further weaken the region’s importance to China which in turn will have less to lose in abandoning the ‘two systems’ policy. Incidentally, even UK’s threat that it is considering giving 300,000 (and 2.9mn still eligible for) British National Overseas passport holders in Hong Kong a path to UK citizenship if China does not withdraw its security law sounded hollow as it could prove highly unpopular at home by the government’s Tory support base which are largely Brexiteers and not too fond of seeing more migrants coming into the country. Although China has initially objected to UK’s offering, we also suspects that Chinese policy makers would not be hugely displeased to see the back of these mainly old-time colonialists. 

Trump can ill afford a trade war given current economic backdrop
With China still looking committed to Phase One of the trade deal struck with the US in latter part of last year, one also senses that US policy makers are fully aware that any retaliation by Beijing in possibly walking away from the trade agreement and potentially halting US agricultural purchases will at this stage have a much more dire consequences for Trump’s political standing among his crucial base of US farmers who had already suffered much economic hardship last year. Moreover, his big push in ending the state lock-downs seems to be already leading to a notable drop in his approval ratings among the US seniors, another of his key support base which have proven highly vulnerable to the spread of the Covid-19 pathogen. 

In short, the political currency of China-bashing looks to be quickly depleting among the US voters who seem more concerned about the handling of the pandemic, the economy and the surging unemployment levels which have surpassed a whopping 40 million in month of May. As we also underlined last week, despite these growing tensions, we think ultimately China’s huge markets will remain a key consideration in preventing an outright trade war with Beijing. Thus, we believe that the US and global stock markets are unlikely to be notably impacted by the current geopolitical tension between the two sides which seem to be more noise than substance.