As external anxieties grow, Japan equities look increasingly attractive
In the US, growing anxieties about the post-election outcome, especially in terms of handover of power should the current president be voted out, has added more near-term uncertainties. With the passing of the US Supreme Court judge, Ruth Bader Ginsburg, efforts by the Republican-led Senate to quickly nominate a conservative judge to replace her before the presidential election has once again deeply polarised and poisoned the political climate, leaving little hope for any agreement for any fiscal relief stimulus to be passed into law anytime soon. With US economy seemingly stalling as underlined by the Federal Reserve chief this week, and colder autumn temperatures raising the spectre of big spikes in infection rates in US and Europe, market sentiment seem highly fragile. Indeed, the VIX fear gauge remains notably elevated relative to August levels while assets parked in US money market funds which we have been closely tracking have suddenly stopped declining last week, perhaps indicating a more cautious tone by asset allocators.
As US stocks continue to sail through choppier waters, the broader Japanese equity market has held relatively firm with Topix still looking technically poised for a notable advance in the shorter-term towards ¥1700 level, where it was trading before the pandemic struck. More notably, the ¥$ rate once again bounced strongly from its 104 lows as it had in August with no notable signs of the Japanese unit being sought after as a refuge to a potential risk-off environment. However, forex remains one of the major headwinds we see regarding our own market in Japan as the exchange rate has struggled to stay above its 50 day moving average ever since the pandemic was declared in March as scope for BOJ to adopt an even looser monetary policy has looked very limited while the Federal Reserve has been far more aggressive in its QE program since then.
Unless the US economy shows a strong enough recovery momentum to persuade the US central bank to step its foot off the monetary gas pedal, it seems highly improbable that the trend of yen strengthening will reverse anytime soon. Moreover, the more notable recovery we are witnessing in China’s economy, Japan’s largest trading partner, could in fact directly help Japan’s economic activity and in turn push the ¥$ rate further towards the all-important 100 level. These counter-acting forces should remain in play for some time and although we have recently turned far more positive about the prospects of Japan’s stock market for the rest of this year, we think forex will remain one potential headwind which corporations and investors will simply have to live with. On the other hand, the prospects for a continued but likely gradual strengthening of the yen and a stronger stock market should leave Japanese equities looking highly attractive as an asset class to notably underweighted overseas investors.
Technology cold war between US and China intensifying
Although tech stocks have held up well in the past week, we retain our generally negative stance towards these names within Japan, where semiconductor-related and component names dominate the sector. We have held this stance since early August and we think geopolitical uncertainties related to the intensifying cold war between US and China are yet to be fully realised, starting with the full impact of Huawei’s ban which came into effect earlier this month. As we pointed out last week China’s foundry champion SMIC was also likely to be sanctioned and most recent reports suggest that the Trump Administration has indeed added the chip maker into its black list. As we also warned, China looks poised to finally retaliate with its Ministry of Commerce last week announcing broader enforcement laws to limit operations of foreign companies that are named in the “unreliable entities” list which is yet to be unveiled.
We think that having seen Apple and many other US companies frantically lobbying Washington against banning their use of WeChat on mainland China where the app remains crucial part of everyday life, Chinese government could itself enforce the ban, forcing Tencent to limit its availability on say, iOS and potentially cutting off Apple’s iPhone from the Chinese market. This would not be too dissimilar to US banning Google in providing its Android OS to Huawei. Although this is a more extreme scenario and China is more likely to have Cisco on their black list than Apple, at least initially, our example underlines great uncertainties facing technology companies and the Japanese supply chain, particularly in the short term as the Trump administration seems to be rushing to exert maximum pressure on Chinese tech corporations before the US presidential election.
Although longer term growth prospects for semiconductors, 5G and other emerging technologies remain solid, we think in the nearer term most companies in the sector are likely to encounter notable air-pockets which may or may not impact their share price. Some argue that the big inventory build-up in memory chips and weaker order trend from data centres have already been factored in. We shall see but we also believe stay and work-from-home demand which have had a huge positive distortion on demand for new PCs and game consoles are likely to be cooling off from the next quarter adding more headwinds. If sales of the 5G enabled iPhone 12 being launched next month also disappoint given the tough economic backdrop, not to mention, patchy 5G coverage for now, we see more sector-specific negatives to be on the short-term horizon. For our current long-only model portfolio and our long/short list of Japan names, please contact us for a free three months trial.