Great turnaround to be kicked off after major political events

BY YUTAKA UDA

Monthly Fund Commentary
16 Jun 2017

BY YUTAKA UDA

In May, the Japanese stock market rose soundly amid retreating uncertainties over US policies, an increased likelihood of an interest rate hike in the US and alleviation of geopolitical risk in Europe. Investors also reacted positively to corporate earnings results with the Nikkei 225 closing up 2.4% MoM at 19,650.6 and the TOPIX closing at 1,568.4, also up 2.4% MoM.

In early May, the market rallied sharply as the yen weakened against the background of easing uncertainties over the US government, helped by Congress reaching a tentative agreement on spending bills for FY2017. Emmanuel Macron was elected as French president on 7th May, thereby reducing the risk that France would leave the EU. On 8th May, the Japanese market rose again, welcoming the French election result with the TOPIX recording its second largest daily rise of 2017. Both the Nikkei 225 and the TOPIX rose further to their highest levels since December 2015 on 11th May, as the yen fell against the US dollar on growing expectations for a Fed rate hike, and as investors responded positively to earnings results at major Japanese companies. However, in the second half of May, the market ebbed and flowed as some investors took profits after the sharp rally between late April and mid May. The Trump administration’s alleged involvement with Russia (the so called Russia-gate), and North Korea’s seemingly weekly missile launches caused some temporary anxiety in equity and currency markets. On 25th May, OPEC agreed to extend production cutbacks at its general meeting, but its impact on the oil price has been limited so far.

In terms of sector performance, 19 out of the TSE 33 sectors gained. The best five performers were miscellaneous manufacturing, foods, communication, construction and utilities, while the worst five performers were marine transportation, oil, mining, textiles and steel.

The Japanese yen started the month at 111.3 against the US dollar, and ended at 110.9. The yield on the benchmark 10-year JGB opened the month at 0.015% and closed at 0.040%.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 31st May 2017 rose 1.2% compared with that of 28 April, while the TOPIX went up 2.4% during the same period. The Fund put no new names into the portfolio with no stocks sold out.

There is an enormous amount of political uncertainty hovering around the world. On 23rd May, the Trump administration submitted details of its FY2018 budget proposal, vowing to increase US economic growth to 3% and to wipe out the US fiscal deficit within 10 years by drastic tax reform and infrastructure spending. It is questionable whether this proposal will be approved by Congress, but it would be true to say that the budget remains an important statement of the White House’s goals, and it can influence deliberations in Congress.

On 1st June, President Trump announced the US would withdraw from the Paris climate accord. On 5th June, Saudi Arabia and three other Arab nations severed diplomatic ties and cut off transport links with Qatar, which could have an impact on the oil production agreement among OPEC countries. Investors are also concerned about the outcome of the FBI former chief Mr. Comey’s testimony to Congress on 8th June. In addition, a series of terrorist attacks on the UK could influence the general election on 8th June. However, the most important thing for the stock market is whether the world economy will continue to grow soundly. Trump’s decision on the budget and climate deal may be positive for world economic growth at least in the short term.

In Japan, the economy is clearly gathering strong momentum. Industrial production in April rose 4.0% MoM with the government estimating that it will decline 2.5% MoM in May and rise 1.8% MoM in June. If the estimates are correct, industrial production in 2Q (April-June) will rise 2.7% QoQ. Labour markets are tightening further with the job offers to applicants ratio climbing to 1.48x in April, the highest level in the past 43 years. Core CPI (excluding fresh food) in April increased marginally to +0.3% YoY from +0.2% YoY in March. But there are lots of items such as beer, butter, utilities and parcel delivery services expected to push inflation higher by September. We think that core CPI may rise more than 1% towards the end of this year. The FOMC is expected to raise interest rates by 0.25 percentage points on 14th June, which may lead to a change of the BoJ’s monetary policy within a few months in our view. The Fed’s decision on 14th June may trigger US dollar strength again and should have a strong positive impact on the Japanese stock market.

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. Cyclical sectors such as steel and nonferrous metals together with energy are also targeted for higher exposure. The Fund retains 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 09/06/17 and are based on internal research and modelling.