Strong earnings being overshadowed by other negative factors
Although corporate earnings have been fairly robust thus far, other factors have begun denting investors’ confidence. With Chinese stocks coming under intense selling pressure due to regulatory and geopolitical concerns while some US market darlings like Facebook and Amazon have provided a more cautious earnings guidance, Japanese stocks have been trending lower with Topix closing near the bottom of its 6 months trading range.
Moreover, recent renewed lockdowns across Southeast Asia look likely to provide more challenges to the global supply chain while severe weather conditions ranging from fierce forest fires to severe floods in the northern hemisphere and more recently, a freezing cold system that has gripped South America, threatening agricultural crops, so called “transitory” inflationary forces at work seem unlikely to ease up anytime soon. In the meantime, wage inflation continues to soar in the US, leaving the Federal Reserve ever closer to tapering its treasury bond purchases.
With Covid infections also hitting daily records in Japan where the Olympic games are taking place, the government can do predictably little but to advise the nation to stay indoors. Although the Japanese Olympic athletes have done more than their share to salvage the event at home by winning record number of gold medals and boosting the nation’s moral, their efforts have failed to improve the popularity of the colourless Prime Minister Suga who is likely to lose the ruling party’s leadership race in September ahead of the Lower House elections that must take place before October 22nd.
Future Covid variants that could evade vaccines worrying experts
With the Covid delta variant now ravaging through most countries and causing ‘break-through’ infections, more variant-targeted booster shots by the year-end are looking increasingly urgent. Meanwhile, in the developed world, governments and corporations are trying to overcome vaccine hesitancy by excluding those not jabbed from the workplace, barring them from travel, restaurants, bars and other leisure venues to keep a lid on Covid-related fatalities.
Meanwhile, medical experts have continued to warn about prematurely lifting restrictions and removing mask mandates which they fear are raising the risks of more vaccine evading mutations emerging from a free roaming virus. Moreover, given the Chinese vaccines administered in countries like Indonesia have provided relatively weak defence against hospitalisation of those infected from the delta variant, questions about how China itself could withstand such a contagion is becoming a concern, especially given the latest clusters discovered in its Jiangsu province.
Japan stocks remains poised for a big rerating
Whether the recent derating of Chinese stocks will by default push global investors to raise their exposure to Japan is a factor which we are watching closely. Certainly, Japan’s market provides plenty of gearing to China without the risks currently associated in investing in the country’s capital markets. However, in order for domestic money which now dominates flows to become big net buyers of Japan stocks again, we need to see the Olympic games coming to its conclusion, Suga-san gone, and vaccinations to continue to rise at its current impressive rate of close to 1.5mn per day.
With Japanese corporate earnings picture thus far looking most encouraging, valuations at very compelling levels and improvement in corporate governance leaving more room for share buybacks and retirement programs, we continue to have high hopes for our own market. Providing there is no major mutation in Covid that renders current vaccines ineffective against preventing mortalities, we expect the Topix index to renew its 2021 highs by the end of this quarter and break higher in Q4 led by cyclical names and re-opening plays.