Markets turning cautious of a trade deal while Japan looks poised for more upside

S&P rally stalls as trade concerns creep back in
S&P’s weekly winning streak came to halt last week as Phase One of US/China trade talks is coming to its business-end and investors are turning more cautious of a possibility that we may yet see another disappointing turn in the ongoing negotiations. With the US Senate passing the HK democracy bill and talks of the US president looking to sign it into law, there are also concerns that US support for HK demonstrators just ahead of the local counsel elections there could derail any potential resolution and US tariffs on Chinese goods scheduled to go into effect in December will do so as planned. 

But tiering the trade deal should help Phase One resolution
Although some caution is understandably warranted, especially given the last minute disappointments in reaching a deal back in May which hit cyclical stocks hard, we think the US stock market is due for some consolidation anyway after weeks of S&P hitting new highs. Moreover, given that trade talks have now been tiered into different phases, precisely to avoid the tougher hurdles for now and agree on the easier issues first, we still think Phase One is likely to go through and the scheduled tariffs will be either postponed further or shelved altogether. 

Still, some caution is warranted as Mr Trump is unpredictable
Although the US president is under pressure by US law makers to sign the HK democracy bill, he seems clearly reluctant to do so and even if he is forced to, we think China would understand his position and is unlikely to walk away from trade talks. Nevertheless, with impeachment testimonies against the US president in the House Intelligence Committee sounding more credible and damning, Mr Trump could easily turn more hawkish again on China and we think it is generally wise to tread more cautiously as we approach the US presidential election next year. 

Bombed out industrial and financial stocks more attractive here
In the past few weeks we have trimmed our recommended buy list of stocks within the capital goods segments, removing some electronic component and automation plays which now look expensive, even on their peak earnings posted last year. We see much better value in industrials, especially restructuring plays that are cutting costs and building up strong operating leverage in the next upturn. We also continue to like the financials which generally look dead cheap with very decent dividend yields and as we have explained previously, could be big beneficiaries of BOJ’s September regime change in tapering its longer-dated bond purchases. 

Potential for steeper yield curve and fiscal stimulus leave us bullish on Japan
It is important to note that a potential for a trade deal is not the only positive prospect ahead. Indeed, with Chinese and European economic indicators showing some signs of bottoming out and calls for fiscal stimulus in EU and Japan becoming louder, there are other encouraging factors appearing that promise to be more supportive. This is certainly true in our market in Japan where we believe BOJ is more determined to steepen the yield curve to improve business conditions for the financial industry while public spending plans called by Japan’s PM most recently could further help underpin demand. 

Targeted public spending and restructuring private sector promising
Talks that the Japanese government is looking to allocate a whopping Y400bn budget for purchasing PCs for schools also anecdotally suggest that future public stimulus may be less wasteful and more targeted to improve the nation’s competitiveness. This is in a stark contrast to LDP’s old pork barrel politics that squandered away trillions of yen in the 90s through building bridges to nowhere and gold-plating motorways. With Japan’s private sector also showing very promising moves in announcing comprehensive restructuring programs, and using more efficient capital cost structures to improve shareholder returns, Japan’s stock market is not only among the best valued DMs but one with the most promise.