Pick up of construction orders likely to trigger an economic recovery

Market Development: A t the beginning of April, Japanese equities largely followed the rally of the US and the Chinese markets on the back of positive March manufacturing data from both countries. Investor sentiment also improved on expectations regarding the US-China trade talks and a nearing final agreement, leading investors to buy economic sensitive stocks. This said, the TOPIX declined for 5 consecutive days towards the 12th of April, after concerns over US-EU trade frictions had arisen and lower-than-expected domestic machinery orders were announced for the month of February.

Monthly Fund Commentary
20 May 2019

Market Development: A t the beginning of April, Japanese equities largely followed the rally of the US and the Chinese markets on the back of positive March manufacturing data from both countries. Investor sentiment also improved on expectations regarding the US-China trade talks and a nearing final agreement, leading investors to buy economic sensitive stocks. This said, the TOPIX declined for 5 consecutive days towards the 12th of April, after concerns over US-EU trade frictions had arisen and lower-than-expected domestic machinery orders were announced for the month of February.

In mid-April, the Japanese market was lagging noticeably, but eventually rebounded. Chinese economic data indicated a recovery, leading China-related stocks as well as machinery stocks higher. The Nikkei 225 rallied for 5 consecutive days towards the 17th, which was mostly due to individual stocks such as Fast Retailing (9983) and Nintendo (7974). On 17th April, the TOPIX marked its highest YTD level so far, surpassing 1630.

In late April, movements in the Japanese market were limited due to investors taking a wait and see stance before the results season, the 10-day long weekend and the start of the new era ‘Reiwa’. Profit taking took place with regards to foreign-oriented stocks, whilst domestic names remained solid. The SOX (Semiconductor) Index declined towards the end of the month on the back of falling semiconductor stocks.

The TOPIX closed the month at 1,617.9 (up 1.7% MoM), whilst the Nikkei 225 ended the month at 22,258.7 (up 5.0% MoM). In terms of sector performance, 21 out of 33 sectors gained, with the five best performers being marine transportation, miscellaneous manufacturing, machinery, electricals and transportation equipment. The five worst performers were utilities, fishery & agriculture, real estate, pharmaceuticals and air transportation.

The risk-on market returned after an apparent recovery in Chinese economic data, the rise in the crude oil price, an increase in the 10-year JGBs yield, and the depreciation of the yen against the US dollar. The crude oil price started the month at 60.14, rising to over 66 mid-month and ending the month at 63.91, whilst the JGB 10-year yield opened at -0.081, finishing at -0.04. The Yen started the month at 110.86 against the US dollar and depreciated to over 112 at one point, before settling at 111.42 at the end of the month.

Market Outlook

With the US President having tweeted on 5th May that the US may increase tariffs on all Chinese imports to 25% due to China backtracking on its pledges to end the trade war between the two countries, the world economic outlook suddenly became gloomy, sending global equity markets lower.

The US-China trade war escalated on 13th May, when China raised tariffs on USD 60 billion worth of American goods after the US had imposed higher tariffs on Chinese goods worth USD 200 billion on 10th May. The world equity markets reacted negatively, with the Japanese stock market recording a 7 day consecutive decline till 14th May. Official negotiations have not been scheduled yet, although some US officials hinted that President Trump would meet President Xi in late June during the G20 meeting held in Osaka, Japan.

According to the Investment Adviser, the market may remain volatile for some time. The team would however like to reiterate that both presidents should be able to find meaningful solutions, hopefully by late June, as they will recognise that they eventually need to share economic and strategic responsibilities for the world.

In Japan, industrial production declined 0.9% MoM in March, lowering Q1 production down to 2.6% QoQ. The government estimates that industrial production will rise 2.7% MoM in April, and again by 3.6% MoM in May, with this estimate potentially being revised down in the future due to the ongoing trade dispute between the US and China.

The team would like to highlight one bright spot in the Japanese economy: According to the Ministry of Land, Infrastructure, Transport and Tourism, construction orders of the 50 largest constructors increased 36.9% YoY in Q1. It appears that the impact of the supplementary budget for FY2018 is starting to appear alongside a steady expansion from the private sector, leading to a sharp increase in orders. QoQ public works spending declined for six consecutive quarters until Q4 2018. This said, the team think that public works will act as leading engine for a sound economic expansion in both, FY2019 and FY2020.

According to the team, the Japanese market should rally once the trade disputes will be settled, as it is lagging other major markets and is comparatively cheap at the moment.

Portfolio Strategy

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 26th April 2019 rose 1.5% compared with that of 29th March, while the TOPIX gained 1.7% during the same period. The Fund put no new names into the portfolio with no stocks sold out.

The Fund has gradually reduced the number of holdings from 40 stocks at the end of 2018 to 32 stocks at the end of April 2019. The Fund continues to be overweight with regards to economic sensitive sectors such as energy, trading companies, machinery and banking. Construction and real estate sectors remain bullish against the background of aggressive fiscal spending. At the same time, defensive sectors such as foods, pharmaceuticals and utilities continue to be avoided.

The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Funds as of 15/05/2019 and are based on internal research and modelling.