We’ve become increasingly nervous of stocks given weak near-term demand outlook in tech space

US stocks edges higher but we feel all is not well in the near term 
Although US stocks continued to edge higher pulling up Japanese shares with them, we stick with our newly adopted negative short term outlook on our own market as we have turned highly cautious of technology stocks which we will address again in this issue. To be sure on, the surface, there are no notable signs of major nervousness with liquidity-driven rally looking intact as S&P is trading close to its all time peak, Nasdaq trading near its recent record highs and the VIX fear gauge holding steady near its 6 months lows. Cash parked in US money market funds which we keep a close eye on continued to edge lower, also reflecting no major signs of investors anxiety. 

But we feel all is not well as bull market bets remain highly concentrated in tech names where fundamentals are starting to deteriorate while much good news regarding release of effective Covid-19 vaccines by Q1 of next year look to be priced in for now. Meanwhile, rising infection and mortality rates both in the US and the rest of the world have left economic activity stuck at suboptimal rates with most businesses still suffering from the demand pull and unemployment rates hovering near their recent highs. Moreover, US lawmakers have failed to agree on extending any of the pandemic-related fiscal relief programs before the summer recess, leaving the economy highly dependant on the short-term band aid provided President Trump’s executive orders placed last week. 

As we have also been highlighting in the past month, geopolitical tension between US and China continues to ratchet up as we get closer to US presidential election in November and US foreign and trade policies towards China become ever more hostile and unpredictable. News of US/China postponing the trade talks to catch up with progress made on last year’s phase one trade agreement was disappointing as there were hopes that this could ease tensions between the two sides in the short term. China’s reported insistence that talks must include negotiations about potential of the US banning of TikTok and WeChat, not to mention, further extending the period of US reprieve in allowing sales to Huawei which expired last week, must have partly been behind postponement of the weekend talks. 

Fundamentals of Japan’s technology companies starting to deteriorate 
Indeed, by Friday, not only Mr. Trump gave ByteDance 90 days to sell its US-based TikTok operations, but he also declared that the waiver on sales to Huawei has come to a close with a promise that sales licenses to the firm will likely to be closely scrutinised and more difficult to attain. In the meantime, there still seems to be much confusion whether the US latest ban of using Tencent’s WeChat by US companies will include the Weixin app used within China given that such a move will likely lead to plummeting sales of Apple’s iPhone in the region and create yet more uncertainty regarding the technology supply chain. 

As we noted last week, we think semiconductor stocks are looking generally more vulnerable as rising of chip inventories have also started to effect orders. Micron’s latest update that memory demand has started trend below its expectations as data centres are now digesting chip stock piles as fears of the pandemic-led disruption had led to over-ordering, echoed a similar warning by Western Digital only a few weeks back. Given that memory ICs was supposed to be the next big driver for recovery in demand for semiconductors, further short-term contraction in demand will not only have a big impact on market outlook for memory chip makers but also for semiconductor materials suppliers and production equipment specialists which are strongly represented in the Japanese market. 

China’s shockingly weak smartphone shipments in July has not helped matters, also raising doubts about the China-led handset recovery which has been the pillar of growth expectations for 5G models this year. Meanwhile, we suspect that the big rebound in sales of PCs and laptops will also start to cool off as work-from-home demand peaks out from here adding more downside pressure on chips and component shipments in the months to come. None of the above draws a very healthy scenario for technology segments which have certainly helped lead Japanese stocks higher this year. We have thus continued with our new strategy of drastically reducing our list of recommended longs in this space while looking for more bombed out industrials with some secular growth angles that trade at low historic valuations and have strong balance sheets.