US/Iran tensions easing while China trade deal to be signed this week
After a brief sell-off at the start of the week on heightened concerns about an impending war between US and Iran, stock markets bounced strongly as neither side looked resolute enough to take the recent skirmishes to another level. Iran’s retaliation after the US killing of its senior general by launching a face saving ballistic missile attacks on US bases in Iraq last Monday looked to have been deliberately designed not to cause any major casualties while at the same time show some use of force to heed the calls of revenge at home.
However, Iran’s air defence system which was on high alert that day, had by its own admission, made a catastrophic error in shooting down a Ukrainian airliner in its own airspace which claimed the lives of 176 passengers, mostly Iranians and those with dual Canadian citizenship. Having already noted that the missile attacks in Iraq “concluded” its military response to the US killing of its senior military leader, this tragic and unintended loss of life looks to have further weakened any immediate resolve by Iran’s regime to further escalate the military conflict. At the same time, this incident has triggered renewed mass anti-regime demonstrations once again in Iranian cities. Iran’s key objective now looks to be using its political influence within the Iraqi government to drive out the US military from its territory.
Mr. Trump’s response to the Iranian attacks also proved muted despite his threats to escalate the conflict should Iran responds. All in all, as we had explained in our last week’s publication, neither side looks to show any intention to take this latest conflict to an all out war–although historically, war has hardly been bad news for stock markets. As we had also expected and far more importantly for Japan’s capital markets, this latest stand-off in the Middle East have eased US trade tensions with China. News that China’s Vice Premier, Liu He will arrive to the US this week to sign the Phase One of the trade deal on the 15th of January and talks of Phase Two to start immediately should provide further Japanese support for stocks this week.
Weak yen and the coming improving earnings trend should also prove supportive
As we have argued during the past quarter, we view the Y$ rate as increasingly a more reliable measure of risk than other fear gauges, including the VIX. It was thus encouraging to see the Japanese unit not strengthening much beyond the 108 level earlier during increased market anxieties and immediately depreciating to its key resistance line of Y109.70 to the dollar which it had been testing since late November. Should the exchange rate break above this hurdle in the coming weeks, we see it surging towards its next resistance level of Y110.50 and ultimately, Y111 which it gapped down from in early May of last year when US/China trade talks broke down.
Needless to add, with most current corporate earnings projections based around Y105 level, we think the yen’s depreciating trend will prove supportive for the stock market. Moreover, early clues to the coming earnings results look even more encouraging. Although results last week by one bellwether name, Yaskawa (6506) showed only a tepid recovery in automation-related orders overall, the more notable improvement in bookings for servo motors and robots in China was enough for market participants to push its shares higher.
This early indication provides a vital clue to the likely reaction of the market to better order trends we are likely to see in technology segments of the market, namely automation and semiconductor-related segments where recovery looks to be well on its way. We thus think our recommended long/short list look well positioned in capturing alpha in the coming earnings season.