Crushing defeat in the Tokyo assembly election should invite more economic stimulus

In June, the Japanese stock market kept rising due to the yen weakness against major currencies and healthy economic data from Japan and overseas. The Nikkei 225 closed the month at 20,033.4 (up 1.9% MoM) and the TOPIX at 1,611.9 (up 2.8% MoM), with both indices recording a three month consecutive rise.

Monthly Fund Commentary
21 Jul 2017

In June, the Japanese stock market kept rising due to the yen weakness against major currencies and healthy economic data from Japan and overseas. The Nikkei 225 closed the month at 20,033.4 (up 1.9% MoM) and the TOPIX at 1,611.9 (up 2.8% MoM), with both indices recording a three month consecutive rise.

On 2 June the Nikkei 225 recovered to the 20,000 level for the first time since December 2015. Since then, softish US economic data (including employment data) were reported, causing the US dollar to weaken against the yen and the Japanese equities to decline.

Overseas political events were carefully watched by investors: Former FBI chief James Comey’s testimony to the Congress was regarded as containing no remarks that would destabilize the US government. Other outcomes from events such as the ECB governing council meeting, the UK general election, the French national assembly election were in line with expectations, apart from the UK election result.

After the FOMC meeting on 14 June during which interest rates were raised by 0.25 percentage points, the yen weakened against the US dollar on expectations for the Fed to continue to hike the key rate, causing the market to rally. The BoJ’s decision on 16 June to maintain its current monetary easing measures was well received by markets as the Japan-US interest differential should widen over the long term, leading to further expectations on the weakness of the yen. Despite the Fed having raised interest rates, the 10-year treasury yield fell to 2.14% on 26 June in response to a run of disappointing economic data, only to surge shortly after. Towards month end, US bank stocks advanced strongly while high tech stocks were sold out.

The Nikkei 225 hit a year-to-date high on 20 June. Crude oil prices fell below 43 dollar/bbl on 21 June, their lowest since last August, before rising for seven consecutive days. In terms of sector performance, 31 out of the TSE 33 sectors gained. The best five performers were banking, air transportation, miscellaneous manufacturing, steel and pulp & paper, while the worst five performers were food, utilities, retail, telecommunications and transport equipment.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 30 June 2017 went up 4.6% compared with that of 31 May, while the TOPIX rose 2.8% during the same period. The Fund put one new name (DMG Mori) into the portfolio with two stocks (Haseko and Mitsubishi Estate) sold out.

The Liberal Democratic Party (LDP) headed by Prime Minister Abe has suffered a crushing defeat in the Tokyo assembly election on 2 July, as City Governor Yuriko Koike’s new party swept to victory. There is no immediate danger of the Abe administration disintegrating, as the next Lower House election isn’t scheduled until late 2018 and Ms. Koike does not have any intention of returning to national politics. Mr. Abe commented that “This is a very stern rebuke from the public that we must do some serious-searching about. The public has sent us a tough message that we have lost our discipline”. We think that for the coming 1-2 years Mr. Abe’s policy will focus more on economic policy and on how to increase Japan’s economic growth to 2%. It will thereby put less emphasis on discussions on revisiting the pacifist constitution.

In the meantime, the Japanese economy is in good shape. A government survey from the Ministry of Economy, Trade and Industry suggests that industrial production in June will rise 2.8% MoM and decline 0.1% MoM in July. If the forecast is right, industrial production in Q2 would rise 2.5% QoQ, which would mark five consecutive QoQ rises. The job offers to applicants ratio continued to rise from 1.48x in April to 1.49x in May. Core inflation (excluding fresh food) crept up to 0.4% in May, from +0.3% in April. According to BoJ’s short economic survey “Tankan” in June, the diffusion index, which measures favourable and unfavourable business conditions for all industries and all sizes, increased from initially 10 in March to 12 in June. Basic industries, machinery and construction industries improved a lot. However, the diffusion index for September is expected to decline to 8.

In the past few quarters, results were always better than previous forecasts, but future forecasts are worse than current conditions. It implies that companies’ management can’t regain confidence regarding the future.

Overall, we think that the government has to pay more attention on stimulative economic policies in the future, thereby laying the foundation to improve business sentiments strongly.

The Fund is increasing its allocation to the machinery and IT service sectors with the conviction that capex will expand significantly due to the more serious labour shortage and potential capacity constraints. Cyclical sectors such as steel, nonferrous metals together with energy are also targeted for higher exposure. The Funds retain a very positive stance towards banks and trading companies, while defensive sectors such as foods, pharmaceuticals and utilities are avoided.

The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Fund as of 07/07/17 and are based on internal research and modelling.