Markets to focus on good fundamentals once political uncertainties vanish

BY YUTAKA UDA

Monthly Fund Commentary
20 Sep 2017

BY YUTAKA UDA

In August, the Japanese stock market started the month on a better note due to favourable earnings announcements. However, it later lost ground amid geopolitical risks surrounding North Korea and political turmoil in the US. The Nikkei 225 declined 1.4% MoM, finishing at 19,646.2, while the TOPIX lost 0.1%, finishing the month at 1,617.4.

The market rose in early August as investors bought into companies due to the positive April-June result season, generating strong earnings. The market also welcomed the slight depreciation of the yen against the dollar following the release of strong US job data on 4th August. However, the market fell sharply on 9th August following US media reports that North Korea was considering launching a ballistic missile into the vicinity of the US territory of Guam.

Criticism of President Trump’s remarks on the riots in Virginia fuelled concerns about his ability to implement policies, sending US stocks lower. The resulting appreciation of the yen against the dollar weighed heavily on foreign demand-oriented stocks in Japan.

Market turnover is prone to falling at this time of the year. The daily trading value of TSE’s first section (large-sized companies) trended below JPY2 trillion for seven straight business days at the end of August. With Tokyo seeing 22 continuous days of rainfall in August for the first time in 40 years, the concern has been that weather conditions will have a negative impact on the economy.

In an interview which followed the recent Jackson Hall symposium, BoJ governor Kuroda emphasized the importance of ongoing monetary easing. On 29th August, the 10-year JGB yield fell to almost zero for the first time in about four months although core CPI (excl. fresh food) continued to rise 0.5% YoY in July. The 10-year JGB yield initially opened the month at 0.083% and closed at 0.009%. In terms of sector performance, 16 out of the TSE 33 sectors gained. In general, energy-related stocks were strong and financials were weak. The five best performers were oil, air transportation, non-ferrous metals, marine transportation and textiles, while the five worst performers were insurance, securities, real estate, banks and glass & ceramics.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 31 August 2017 declined by 0.2% compared with that of 31 July, while the TOPIX declined 0.1% during the same period. The Fund put one new name (Sumitomo Chemical) into the portfolio with no stocks sold out.

Currently, there are lots of uncertain political factors around the world. September is likely to be a critical month for global markets. The US is calling for new UN sanctions against North Korea, including a ban on oil imports and textile exports as well as an overseas employment stop of North Koreans in the wake of its sixth and largest nuclear test on 3rd September. In this regard, the US might however struggle to gain support from China and Russia.

On 7th September, President Trump struck a deal with the Democrats to increase the debt limit and finance the government until mid December. Some key members of the Republicans are however known to be unhappy with this decision, casting a shadow over the discussion on the federal budget, tax cuts and the infrastructure spending plan in the coming few months.

In Japan, the economic landscape is improving. Real GDP for Q2 rose 2.5% QoQ annualised, recording six consecutive QoQ rises. Domestic demand grew with a good balance across the board. Notably, public works led the expansion with a 6.0% rise QoQ annualised, triggered by a large fiscal stimulus package implemented last October and the ongoing projects related to the Olympic Games in Tokyo in 2020. Industrial production in July declined 0.8% MoM after a big jump of 2.2% MoM in June. The government forecasts that industrial production will rise 6.0% MoM in August and decline 3.1% MoM in September. If the forecast is right, industrial production in Q3 would increase 2.3% QoQ.

Prime Minister Abe is expected to call for the next extraordinary Diet on 25th September, at which the government should focus on additional economic stimulus measures to achieve the 2% growth target for the coming few years. If political uncertainties vanish, the Japanese stock market should start a rally with investors’ recognition of cheap valuations and high profit growth. We expect companies to revise earnings forecasts for FY2017 up and increase shareholder’s return once corporate profit results for 1H 2017 will be announced during late October to mid-November.

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, and chemicals 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 12/09/17 and are based on internal research and modelling.