Sentiment change in the US leave us wrong-footed in Japan stocks

Just when we were becoming more cautious of Japanese corporate earnings outlook, the sudden change in perception in US macro factors have drastically improved sentiment and as we move away from the recent summer lull. In the US, investors are leaning back towards a no-landing scenario of rates more or less looking to have peaked in line with inflation rate and employment rate remaining fairly steady. This Goldilocks outlook combined with hopes for China to stimulate demand have proven a potent bullish mix for stocks.   

Indeed, in our own market in Japan, Topix has quickly rebounded on its key support lines, breaking above its recent summer highs and leaving no notable resistance until ¥2450 level (+4%) last tested in June 1990. Interestingly, Topix is also catching up with the Nikkei’s performance this year as the rally has broadened beyond just techs and multinationals. 

This run has also reignited bullish talks of Japan’s low valuations and continued improvement in shareholder returns. Some also argue that weaker yen has made Japanese stocks even more attractive to dollar investors. Indeed, it is also notable that even in dollar terms, the broader Japan market is still outperforming most major European stock indices this year and only lags S&P, and more notably Nasdaq. We concede that this could encourage more overseas capital inflows into Japan in the near term.  

With ten-year JGB yield seemingly settled below 0.7% and dollar/yen rate hovering just above 145 there is also a sense of calm returning to markets. In the meantime, Japan’s economic growth seems to be slowing, dragged down by tight household budgets and weakening capital outlays that some suggest should keep yields differentials with US steady from here. We also know that this dislocation between weakening economic outlook and stock market’s rerating could easily continue, especially given what investors are currently enthused about. 

To be sure, we don’t think BOJ is out of the woods yet as core inflation remains a problem and labour shortages are simply too severe not to expect wage pressure from here. Rising oil and import prices in general that weak yen fuels is also an issue unlikely to go away. Ultimately, we think BOJ will have a battle on its hands to keep rates from surging. We also suspect selling pressure on the yen will likely persist as even a steady rate differential is encouraging enough to continue with yen carry trades. 

But given that this publication is mainly concerned about the likely near-term market outlook, we always remain humble to markets and sensitive to any major sentiment changes. We now think that our worries about peaking earnings among Japan’s manufacturing exporters and multinationals might not be hugely relevant to broader market’s direction. This may be especially so for the near term as the yen’s most recent plunge has raised their earnings buffers once again.