Japan earnings showing improving signs while we remain negative on techs and video game stocks

Positive earnings signs in Japan from recovering consumption and China demand
It was rather a dull week with S&P eking out a small gain after a big rebound in stocks in the previous week as continued spread of Covid infections in the US and Europe and concerns about temporary halt in some vaccine trials as well as leaked WHO study showing disappointing results in effectiveness of Gilead’s drug, remdesivir, weighed on sentiment. With less than three weeks left before the US presidential election, concerns also linger that no economic stimulus seems likely before then as a compromise among legislators on the size of the fiscal package still seems far away. 

In the meantime, sentiment in our own market in Japan was also somewhat lacklustre with Topix struggling to close its bearish gap formed in late February around 1640 level with lower trading volumes seen for much of this month. Even the smaller cap names which have been on fire in the last few months, retraced some of their earlier gains made by mid-week after Topix Mothers Index briefly broke above its early 2018 highs. The retreat was partly triggered by the ¥$ rate which once again failed to stay above its 50-day moving average as it has been the case since the pandemic, continuing with its downward slope which we believe will eventually push the forex level towards parity. 

Nevertheless, we retain our bullish stance on Japan as we are already seeing more positive earnings projections and results emerging from a general recovery in consumption trends at home and more notable improvement in end-demand in China, Japan’s largest and most important trading partner. We feel these two factors will be the two key pillars, supporting the market, especially as the yen is weakening against the Chinese currency. This should help offset some of the headwinds from the stronger yen against the dollar as well as the fact that the US and EU look likely to struggle to maintain their economic recovery trend given the renewed surge in infection rates and lockdown regimes being reintroduced.

We retain our negative stance on technology and video game stocks
With Apple’s launch of 5G enabled iPhone12 models having brought very little surprises, we remain doubtful over the strength of the replacement demand cycle given tough economic conditions and very patchy 5G network coverage. With this, much-anticipated event now behind us and with market looking to have already factored in a very positive outcome of an iPhone super cycle, we think surprises look to be eschewed towards the downside. This is especially so as China’s smartphone shipments continue to plunge, falling by a whopping 37% YoY in September while we have yet to see the full impact of the Huawei ban on orders for smartphone component makers. 

To be sure, we have seen some fundamental improvements in tech space, especially supply/demand in data centre components as they have continued to absorb their high level of inventory in the last quarter. However, with inventories of memory chips said to have reached as high as four months by August, it will take some time, possibly as long as Q2 of next year before lower stock piles feed through to improving end-demand. Moreover, with strong work-from-home PC and notebook sales likely to be cooling off from the current quarter, we feel that scope for disappointing demand trends in the technology space will linger on for a while. 

Another sector which we think is fertile ground for finding short selling opportunities and has seen a very positive distortion from the pandemic is the video game segment. Most related shares in Japan are trading close to their all-time-highs with nearly all analysts upgrading their earnings growth projections for next term. However, with this year’s likely prospects of having three Christmas quarters in one term, we believe the growth hurdles for next year will prove extremely high and with the new game consoles cycle at its early penetration stage, probabilities for sales growth to continue into next term seems fairly remote. We think this sector led by Nintendo looks ripe for a notable correction.