Focus turns to the timing and size of the supplementary budget

BY YUTAKA UDA

Monthly Fund Commentary
19 Jul 2016

BY YUTAKA UDA

In June, the Japanese market suffered its largest decline since the Greek crisis in May 2012. The day after the UK’s EU referendum, the Yen strengthened to 99 against the dollar at one point and indices such as the TOPIX and Nikkei 225 declined the most since the IT bubble burst in April 2000.

On the 1st June, disappointment arose when Prime Minister Abe did not mention any concrete economic stimulus when announcing a two-and-a-half year delay of the sales tax hike, and the market declined significantly. On the 3rd, US employment data for May fell short of market projections, and expectations that the Fed would raise interest rates in June declined which caused the Yen to strengthen against the dollar. This prompted selling in Japanese equities particularly exporters and financials. However, the secondary preliminary estimate of real GDP growth for the Jan-Mar quarter which was announced on the 8th was revised upwards and the market regained confidence. The number of overseas visitors to Japan in May remained at a high level but showed a slow-down in growth of 15% YoY which is likely to be the result of less days of holiday than in the previous year. When the Fed actually shelved a June rate hike on the 16th and the BoJ decided to maintain the current monetary policy, the Yen appreciated further. The result was a broad sell-off in Japanese stocks, led by exporters. On the 24th, when it became clear that the ‘leave’ camp had won a majority in the UK’s EU referendum, the Yen strengthened to 99 against the dollar and the market declined at the greatest rate in more than 16 years. The following week, the Yen slowly depreciated and the market recovered gradually towards the end of the month.

The TOPIX closed the month at 1,245.8 (down 9.7% MoM) and the Nikkei 225 at 15,575.9 (down 9.6% MoM).

In terms of sector performance, all 33 sectors depreciated. The best five performers were domestic defensive sectors such as pharmaceuticals, retail, food, land transportation and communication. The worst five performers were securities, insurance, miscellaneous finance, banks, and rubber.

The Yen started the month at 110.7 against the US dollar, at one point appreciating sharply to 99 before declining gradually and ended the month at 103.2.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 30 June 2016 went down 12.5% compared with that of 31 May, while the TOPIX declined 9.7% during the same period. The Fund put no new names into the portfolio with no stocks sold out.

The bond market is looking overheated. The yield on 10-year JGBs opened in June at -0.12 and closed at -0.23. At one point, the yield fell to -0.24, much lower than the historical low of -0.14 recorded in April. In early July, the yield on 20-year JGBs fell below zero for the first time ever and the 30-year yield was at just 0.015% as investors sought safety. The Investment Adviser thinks that negative interest rates on 20-year JGBs is very technical, illogical and temporary. Core CPI (excl. food and energy) in May stood at +0.6% YoY, although the growth rate is declining. It is very unlikely that core CPI will go below zero in the foreseeable future, judging from current economic conditions and the pay rise trend of 2% p.a. Investors are trying to make money by investing in positive yield bonds like 40, 30, 20 year maturities with a strong belief that the BoJ will buy at a better price eventually. It is a very dangerous game; however this may continue until the Upper House election is held on 10th July, since the market believes that the government could not take action regarding economic policy before this. According to MUFJ Morgan Securities, the BoJ is likely to reduce monthly purchase amounts of long bonds to JPY9.26 trillion in July, the fifth consecutive MoM decline, which may suggest that the BoJ is worrying about the “current overheated situation”. After the election, Prime Minister Abe could start to consider the timing of his economic stimulus policy. He hinted in early June that a comprehensive economic stimulus package, including a FY2016 supplementary budget, would be decided upon in September. But he may front load the announcement having considered world market turbulence after Brexit and the sharp appreciation of the Yen. The market should pay every attention to the timing and the size of the supplementary budget. The Investment Adviser believes that this announcement should change the direction of bond markets rather dramatically and should also be the trigger for the stock market to start a remarkable recovery, with economically sensitive stocks leading the rally.

The Fund is increasing its allocation to the machinery and IT service sectors with the conviction that capex will expand significantly as the labour shortage is getting serious and capacity constraints are emerging. A dramatic expansion of inbound tourists towards the 2020 Tokyo Olympics should contribute to real estate and construction sectors. The Fund retains high weightings in 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 14/07/16 and are based on internal research and modelling.