Some top-down thoughts on markets for near term

Deteriorating earnings visibility continue to weigh on stock markets with techs and other growth names leading the way down. US earnings season has provided little positive catalysts while investors remain focused on the macro picture, and more specifically, on inflationary trends. Fed’s 50bps hike (which ticks off one of this year’s predictions made in our late December publication) still leaves it with much to do to get ahead of the curve.

With current spending on leisure and travel surging in the West as Covid is for all practical purposes now regarded as endemic, we suspect rising inflationary pressures are likely to become more problematic in the service sector, particularly labour costs. Meanwhile, sales of consumer goods seem to be struggling as household budgets are being squeezed. This change in spending patterns which we addressed last week is bringing with it a feast or famine scenario that is almost a mirror-image of the past two years.

In China, the country’s Zero Covid strategy continues to weigh heavily on  sentiment. Indeed, recent statements from its politburo dismissed any possibility of backing down from its draconian pandemic measures. Given that politics rules out the use of foreign vaccines, until China develops more effective homegrown jabs against Omicron and its sub-variants, it seems likely its economy will remain depressed in the near term. 

Also, the realisation that the supply chains in China might not be as reliable as previously thought, coming on top of elevated geopolitical risks, seem to be accelerating reshoring and generally diversifying supplies away from the country. We are seeing that in factory automation-related orders by regions from the bottom up as the highly automated plants are generally the easiest to rebase. 

Moreover, with China not showing any willingness to help mediate a ceasefire in Ukraine and to demonstrate its importance as a balancing global soft power, we think it is missing a big opportunity to improve its global standing. Instead, Western policy makers are sounding ever more hawkish about future China policies with Europe calling China “tone deaf” in regards to concerns about Russia after their top-level meetings last month. 

In our own market in Japan where weaker yen is generally viewed positively for listed multinationals, Topix has held out better than most developed markets in local currency terms this year. However, in dollar terms it is down by over 15%, mainly due to BOJ’s continued zero interest rate policy which has led to rapid devaluation of the yen.

This not only raising import costs in Japan but we think the weak yen is starting to look destabilising for other Asian currencies that could turn into a contagion. With Japan’s Upper House elections to be held before the end of July, squeezing household budgets is becoming a major headache for the Kishida government and the ruling party. 

We suspect political pressures on MOF is mounting to force BOJ to change course by allowing longer term rates to move higher. This is especially so as the inflation gauge is nearing BOJ’s targeted 2% level. Moreover, the bank’s governor, Mr Kuroda’s assessments that weak yen is positive for the economy and current pricing pressures are only “transitory” are sounding increasingly out of touch as other central banks tighten up. 

We suspect BOJ will soon either be forced to raise its targeted yield ceilings for longer dated JGBs, or simply stop its special buying programs designed to suppress long term rates. Either way, this potential regime change could trigger a dramatic divergence in performance of Japanese stocks with financials likely to be among the big winners.