Japan stocks look poised for big gains in Q4 but China risks loom

As US rates head back up, Japan stocks look poised for further gains
Having spelt out its plans to start its tapering before year-end and complete the program by middle of next year, the US Federal Reserve’s intentions seemed well communicated as US stock market investors took the tightening stance in their stride. Having been weighed down by recent debt default concerns in China, US shares staged an impressive rebound, led mainly by cyclicals and value names which had struggled since US long term rates peaked in March.

As we have noted throughout the summer when long term rates were plunging back towards February lows, not only we think inflationary pressures look far less transient than the US central bank was initially guided for, but with US unemployment rate on a gradual downtrend, we continue to believe bond yields should bounce back towards this year’s highs. This scenario has kept us very bullish about our own stock market as Japan’s bourse remains highly economic sensitive and looks poised for big advances in the coming quarter.

With LDP leadership race entering its final days before we know who Japan’s next PM will be, we remain excited about the prospects for reform, especially if Taro Kono gets the top job. We hope that this could also usher in a new era of economic policy that shifts its reliance away from BOJ’s ultra-loose monetary policy which has greatly hurt banks’ margins as well as depressing investment returns. We think such a policy shift not only puts Japan more in synch with other developed economies but could lead to a dramatic rally in shares of Japan’s financial institutions for the rest of the year.

Geopolitical disruption risks rising as techs look vulnerable for 2022
We were not at all surprised to hear that the Biden administration is said to be considering launching an investigation into Chinese subsidies under Section 301 of the U.S. trade law, which could lead to new tariffs. Given China’s industrial policies which rely heavily on government subsidies, we think geopolitical tensions are only likely to rise as we think it is highly unlikely that Beijing would consider changing anything it sees as essential to its economic success.

With the latest four nation Quad Summit (US, Australia, India and Japan) seemingly taking a more official status in an attempt to keep China’s expansionist policies in South China Sea at bay and another alliance called AUKUS being established between US, UK and Australia to help the latter nation strengthen its naval force operating in the Pacific Ocean, we have little doubt that we are at a cusp of another cold war that could eventually force countries to sever economic ties with China. We also think that the chances of China’s latest bid to join Trans-Pacific Partnership being accepted by its existing members is close to nil. 
As we have previously underlined, we see export restrictions of technology to China likely to broaden further from here, potentially hurting earnings prospects of many suppliers of capital goods and materials. Thus, we see trouble ahead beyond our next quarter’s bullish outlook for Japan’s stock market. Although the timing of such geopolitical disruptions is obviously hard to predict, we think the writing is on the wall and the sector that looks most vulnerable in 2022 is technology.