Stocks remain supported for now but Trump and Abe’s geopolitics must be watched carefully

Markets remain calm for now but geopolitical tensions rising 
US stock markets have remained relatively calm for now with tech-heavy Nasdaq once again outperforming other stock indices while VIX or the fear gauge has fallen back to its 200 day moving average, a level which it had bounced back from in early June. The calmer markets came despite US Covid-19 infection rates hitting daily records and hospitalisation rates surging again, testing our thesis that with a staggering $4.6tn still sitting on the sidelines in the money markets, downside risks to stocks should remain relatively low in the very short term. With most US states and countries coming out of nationwide lockdowns, the world is coming to terms with the fact that until effective vaccines are produced in their millions and distributed globally which should at the earliest arrive in the first half of next year, the spectre of rising infections will remain with us for a while to come. 

However, as we also pointed out last week, one major downside risk to stocks could come from geopolitics. With Mr. Trump looking notably behind his rival in most recent polls in the run-up to November’s presidential election, we argued that if the US president sees his chances of being re-elected slipping away, there is a possibility that the US administration abandons its effort in regaining public support and similar to its move in appealing to Supreme Court to invalidate Obamacare in the middle of a pandemic, it can also drastically cut the government’s fiscal support for the economy and/or resort to more hostile ‘scorched earth’ tactics towards dealing with its major trading partners, EU and particularly China. 

The latest US moves in beefing up naval fleets in South China Sea and diverting more of military personnel from European and Middle Eastern bases to those in East Asia are all troubling developments which could unhinge stock markets. Perhaps the calculation is that at least an appearance of a potential for an armed conflict with China could sway US voters to to re-elect the incumbent government. Come what may, we see geopolitical tensions only rising from here and although smaller military conflicts in the past did not have a lasting negative impact on stock markets, one with economic and military might of China could indeed unsettle markets over the next few months. 

Abe also adopting populist policies to improve his domestic standing 
This week we focus on geopolitical tensions brewing between Japan and its key trading partners which we also find troubling. Although the country, seemingly by luck, has thus far managed to avoid the fatalities seen from Covid-19 infections, government’s own efforts to contain the virus has been nothing short of shambolic. With number of tests done thus far having yet to surpass 0.5% of the population, to say that the authorities are flying blind in knowing how many are infected is an understatement. Nevertheless, either by Japan’s high standards of hygiene, and other social norms such as not shaking hands, wearing facial masks, or according to some medical theories, a naturally high level of antibodies from previous viruses that have provided the nation adequate protection from Covid-19, the country has by in large avoided high death rates seen in other countries.

Despite this fortunate outcome, Prime Minister Abe has seen a steady drop in his popularity in recent polls and is seemingly also looking to stir up regional tensions with its key trading partners to potentially improve his current standing with Japanese voters. His latest effort to convince the US in not inviting South Korea to the next G7 summit is a case in point. Having removed South Korea from its ‘favourite nation’ trade status last year and having forced Japan’s semiconductor material suppliers to apply for export licences to ship their products to Korean chip makers, we believe Abe’s policies have triggered a major efforts by South Korean government and the nation’s tech giants to wean themselves off from Japan’s upstream suppliers. This provocation had also greatly hurt sales of Japanese brands in South Korea last year as many consumers had decided to boycott purchasing Japanese goods. Nevertheless, these policies also helped buoy Abe’s popularity at home and could explain his latest efforts to try to alienate South Korea again. 

What is even more troubling is that senior LDP lawmakers are urging the Abe government to cancel Chinese President, Xi Jinping’s state visit to Japan hoped for this year, pointing to China’s introduction of security law in HK as a cause of growing contention. At the same time, Japanese policy makers are reportedly approaching financial firms based in HK to try to lure them to move their Asian hub to Tokyo with aggressive incentives. These are all partly due to pressures on Japan to stand with its key US ally and his good friend, President Trump against China. However, it also seems to be an effort to tap into growing Japanese public sentiment against China over the pandemic. However, given that China is Japan’s largest trading partner by far, a similar policy stance to what the Abe government has adopted towards South Korea could have a devastating impact on Japan’s economy and its exporters.