Why we think Japan will outperform other majors in Q4 and beyond

Japan and its deep cyclical/value names likely to outperform
We will keep this weekly update short as we switch to a bottom-up mode ahead of the earnings season which for three weeks a quarter make markets more bearable and interesting.

But to summarise our key calls, we remain bullish on Japan and expect September’s highs in Topix to be tested and surpassed by the year-end. Indeed, Japanese stocks rebounded nicely last week as worries about new government’s economic policies were brushed aside and a relief rally in growth stocks as well as cyclical lifted all boats.

We think as long as treasury yields remain on a steady uptrend, Japan should outperform other majors, up or down from here, especially as input costs should prove a far muted problem for its corporations in the shorter term. We also don’t think some of the inflationary forces in play will prove transitional enough to justify yields where they are today. 

Also, we think our key premise behind suggesting going long cyclical/ deep value plays as well as re-opening beneficiaries remains intact. With increasingly more governments now accepting to live with Covid, we suspect we will start seeing a more evenly spread economic recovery from next year.

Another likelihood is that the Fed’s tightening will be far more measured, cautious of creating any disruptive tantrums and dislocations in capital markets and its future policy and tweaks are likely to be clearly communicated. This only means that US yield curve could steepen drastically helping financials.

However, growth stocks also rebounded last week as treasury yields dropped back a little, led by tech and capital goods names where we have some key suggested short positions going into the earnings season. Yields aside, although the US earnings picture has been positive thus far, we have yet to see earnings reports from key sectors which are more vulnerable to rising input costs and supply disruptions.

We believe that techs and factory automation plays remain fairly vulnerable, not only to supply disruptions that have hit output but also to weakening end-demand in some segments, especially from exhausted benefits of work-from-home-related which will make inventory management trickier over the next few quarters. But with auto output likely to be bottoming here as semiconductor supplies improve, a whole sway of industries in Japan are likely to benefit from what is to come. 

With Japan’s vaccination rates rising to adequate levels which should allow opening up travel corridors before year-end, the weak yen helping earnings outlook and logistics bottlenecks at ports looking to have passed peak volumes of the year-end rush, we look to be heading into Q1 of 2022 on a generally much sounder economic footing, despite rising input costs and the recent slowdown in economic activity.

The spoiler of course, is a realistic prospect for a cold war with China where tighter export restrictions to the country could wipe away a huge chunk from order books of Japanese firms. But for now, all eyes on the earnings results and guidance.