US stock market melt-up continues but Japan continues to shine among other DMs
Continued excitement over the likelihood of swift approvals of Covid vaccines in the coming month together with a less combative tone towards the election result from the outgoing US president who seems to be finally allowing for the formal process of transition of power to take place have all helped to continue to push markets higher. Moreover, Janet Yellen’s nomination as the next Treasury Secretary of the Biden Administration has also pleased investors, encouraged by the likely closer cooperation between US Treasury and the Federal Reserve.
With almost all market segments rising, from large to small caps, techs to cyclicals, ‘back to normalcy’ trades and pandemic beneficiaries, it is difficult to see any major factors besides the obvious fact that stocks simply want to continue to head higher as liquidity-driven rally rages on and with $4.3trn still parked in US money market funds, it hard to overlook the size of cash sitting on the side-lines. The VIX fear gauge also briefly fell below its critical 20 level on Friday, its first dip south of that line since February and further underlining the risk-on sentiment. Curiously, such optimism has failed to notably appear in the US treasury bond market which have been trading sidesways with some observers suggest that the Fed’s more aggressive QE program could be currently keeping yields from spiking up.
Our own market in Japan also continues to shine with Topix now above its pre-pandemic year-highs (up nearly 4% YTD) and closing in on our year-end target of Y1900 level (up by over 6% from here) last reached in early 2018 before US trade sanctions on China became a major headwind for cyclical names. Since early September we have argued that with cyclical stocks likely to outperform, we think Japan looks the most attractive developed market given its highly cyclical nature, attractive valuations (of 16x average forward earnings and 1.2x book), firmer economic recovery trend of its biggest trading partner, China and Corporate Japan’s generally healthy balance sheet. With the yen also firm and likely to remain so, dollar-based returns in Japan have looked even better with Topix now at the same levels of its 2018 peak.
Our September strategy of shorting some big techs in Japan fails miserably
Although we have had plenty of undervalued technology laggards in our long list which have done well in the past few months, our strategy of shorting some of this year’s big tech out-performers in Japan from September proved to be a very poor one. At the time we thought that the oversupply in the memory market and big inventories stockpiles at data centres would lead to depressed chip prices and should curtail capex plans until at least H2 of next term. We also felt that much of the strong demand for PCs and notebook, propelled by work-from-home trends are likely to be exhausted by the end of this year adding more headwind in 2021.
Moreover, with Huawei’s front-loading of its component purchases ahead of the US ban coming into effect last September further distorting the picture, we thought smartphone component sales from this quarter could come under pressure. We were especially worried about market’s over-excitement about Apple’s launch of 5G-enabled iPhone 12 models which we thought could underwhelm given the weak economic backdrop and patchy 5G coverage which for now provides a less convincing user experience.
Although fundamentally, we think the above scenario is still realistic, it has not transpired to any under-performance in our tech shorts as investors have seemingly chosen to look beyond any near-term weakness and continue to push their valuations higher. In fact, most of our technology short picks have rebounded strongly this past month, breaking above their summer highs and forcing us into a stop-loss strategy that is never pleasant. It is also fair to say that shorting anything in this year’s market has proven hugely challenging given the quick rotational buying we have seen from one sector to next that has brought technology names back into vogue.