Stock remain well supported for now but dark clouds gathering on the horizon

Recent economic rebound likely to stall leaving a more challenging economic backdrop
As tech heavy Nasdaq index continues to reach new highs, S&P has also held steady, looking technically poised to test its June highs as anticipation of positive results from handful of Covid-19 vaccines which are in their last trial phase is starting to build up. Some market observers have been pointing to generally weak trading volumes, and continued elevated levels of volatility in calling the recent holding pattern by the broader US stock market as an unstable equilibrium. They argue that markets remain vulnerable to realities of a very weak economic backdrop which is further challenged by the recently raging Covid contagion. This has left prospects for a continued rebound in economic activity beyond the short term impact of reopening businesses as highly improbable.  

We have argued that with near-record $4.6trn of cash still parked in US money markets, stock market’s downside risks in the very shorter term seem fairly limited as the liquidity support by the Federal Reserve have been ample and capital markets are still functioning well. However, we also continue to believe that much of the risks over the next few months could come from the unpredictable Trump Administration and other policy makers in regards to continued fiscal support for the unemployed and smaller businesses beyond this month, not to mention, potential for exogenous geopolitical shocks which could unhinge the markets as tensions between US and China ratchets ever higher and as the US president looks for ways to improve his abysmal poll standings ahead of the election in November.  

Nevertheless, persistent high levels of unemployment combined with elevated economic uncertainty leaves most businesses outside of the technology space as fundamentally challenged. Even as world economies come out of their respective lockdowns, it is already clear that consumers will remain more cautious until emergence of effective vaccines remove health-related fears and consequently pave the way for some degree of behavioural normalcy and some form of lasting economic recovery. Until then, what some economist has cleverly termed as “experience-induced frugality” should persist among consumers, leaving economic activity operating at sub-optimal levels. Given the above scenario, we retain our usual defensive posture in suggesting to remain overweight technology stocks where visibility continues to improve in line with the fast growing global digital economy while recommending to remain under-exposed to traditional cyclical and industrial names until we have a better idea of what the future holds.

Japanese stock market continue to closely follow US stocks
As Japanese stocks remain much more attractively valued than their US counterparts and with overseas investors notably underweight yen-denominated equities, we have argued that investors could do far worse then being overweight Japanese equities. However, it is also worth mentioning again that Japan stocks continue to move up and down in line with US markets, also closely following sector moves and themes that come from there. This is despite BOJ having been a proactive buyer of Japanese stocks while thus far, the Fed has refrained from intervening by purchasing US stocks. So in terms of diversification of risk assets, Japan has provided little strategic value. 

As we mentioned last week, there are also some potential geopolitical risks facing Japan as its Prime Minister looks to follow the footsteps of his friend in the White House, by stirring up regional tensions with South Korea as well as China to regain some lost support among Japanese voters. With levels of Covid-19 testing having been woefully inadequate, only recently breaching 550K or less than 0.5% of total population, PM Abe has managed to do what Mr. Trump could only dream of, by keeping the level of tests low and thus suppressing number of reported positive infection cases. Although as we also explained last week, Covid-related fatalities seemed to have remained fairly well contained thanks to what some have argued to be Japan’s high level of hygiene standards and thanks to its social norms, a recent surge of infections in metropolitan areas, namely Tokyo have raised the risks of rising number of hospitalisations in the coming weeks. 

We think any major resurgence in level of infections leave Abe’s government highly vulnerable as much precious time has been squandered by policy makers’ complacency and failing to raise the level of testing which has now left them flying fairly blind. Interestingly, government’s recent campaign, “Go To Travel”,  designed to aggressively stimulate Japan’s domestic tourism has been met with much criticism among its key support groups of dwellers in the country side and rural prefectures who do not want visitors from cities to bring with them potentially higher exposure to the Covid-19 pathogen.