Despite surging infections we see limited near term downside risks, particularly in Japan stocks
Although Covid-19 infections have been raging unabated across the world, as we have underlined what matters most in terms of world stock markets is what is happening in the US. As we have also highlighted, the situation there has become increasingly grim as daily nationwide number of cases have surged to record highs once again as states that have prematurely eased restrictions are generally the ones seeing the highest tally of infections and hospitalisations. Although we had been anticipating higher volatility to return to markets in July as growing realisation of a prolonged sub-optimal economic activity casts grave doubts on any v-shaped recovery scenarios, the resurgence in infections looks to have brought this home slightly earlier than we had expected.
Still, going back to our original thesis behind the market’s liquidity driven rally since March, with over $4.6trn of funds parked in the US money markets, we continue to believe that near term downside risks in stock market indices should remain fairly limited. This is also very relevant to our own market in Japan which more or less moves in tandem with US stocks, leaving any fundamental analysis of local forces in play as a futile endeavour. However, we should add that BOJ’s aggressive equity ETF purchases which put an end to any price discovery process months ago is still a major source of market support. Meanwhile, more compelling share price valuations as well as Corporate Japan’s generally strong balance sheet derived from avoiding any wasteful Western style share buybacks also keep us generally confident that global investors could do far worse than being overweight yen-denominated stocks at this stage.
Moving on, we continue to expect technology names to outperform given that the pandemic has only accelerated the adoption of the digital economy. Meanwhile, we expect much of the short term weakness to come from deep value cyclical, industrial as well as travel-related stocks which briefly started to outperform before markets peaked earlier this month. Although total easing of global lockdowns look unlikely in the short term and could prove more patchy and gradual than they seemed only a few weeks ago, we continue to believe that going back to nation-wide closures of businesses are politically and economically untenable in most countries.
With Trump’s days looking numbered, he might resort to ‘scorched earth’ tactic
Despite this somewhat benign scenario, there is an alternative outlook that points to potential geopolitical risks ahead of the US presidential election. As we highlighted last week, more fiscal measures are needed past July’s deadline to continue with payment protection and unemployment support programs to keep markets calm. We also noted that given that we are entering the vital last months in the run-up to the US presidential election race, this scenario seemed likely, especially as the recent polls seem to suggest that the US president is facing heavy defeat in November. This also concerns number of Republican senators which could also lose their seats in November and with them, the party’s slim Senate majority. This might also indicate that even if Trump did get re-elected, it could leave him a lame duck president who could face another and more realistic chance of impeachment as Democrats will likely dominate both legislative chambers.
However, the potential for the above scenario could have the US president dangerously cornered and could in fact have an opposite effect to what we have been hoping for. We are starting to think that realisation that he is facing certain defeat could lead the Trump Administration in adopting a more confrontational US policies over the next few months. Indeed, the administration’s latest Supreme Court filing to invalidate the Affordable Care Act, one of Obama’s key signature policies that Trump has yet to undo took us by a major surprise. To potentially try to remove health insurance policies of millions of US citizens in the middle of a pandemic seemed an odd move to make given what the polls are currently suggesting.
Thus, this could be a rude reminder that one should not disregard the potential for Trump to adopt what could be best described as a ‘scorched earth’ tactic, knowing that he is going to lose the presidency anyway and not caring much for the damage the GOP will sustain for years to come after his reign is over. In such a scenario, anything is possible including an all out trade war with Europe as recent moves might suggest. Indeed, in such a case, potential for a more serious anti-China policies cannot be dismissed either. Although China has been accelerating its purchases of US agricultural products in order to keep farmers, a vital part of Trump’s support base happy, if the US president has already concluded that he will lose the election anyway, this might no longer matter to him either. We thus, keep a very close eye on the latest US economic and trade policies for clues of which path Mr. Trump might take over the next four months.