Supplementary budget to be the catalyst for a sharp economic recovery

BY YUTAKA UDA

Monthly Fund Commentary
18 Oct 2016

BY YUTAKA UDA

In September, thin trading continued as investors adopted a “wait and see” stance ahead of policy meetings of the BoJ and the FOMC scheduled on 21st September. After these events, there was a lack of enthusiasm in the market and Japanese equities declined along with US and European stocks.

At the beginning of the month, the market gained as the yen depreciated, continuing the trend from August. On the 5th September, the Japanese market rose after Wall Street’s rally upon the announcement of US employment data, and the Nikkei recovered to over 17,000 for the first time in 3 months. However, after US economic data was weak, expectations retreated for a US rate hike which caused the yen to strengthen against the US dollar and this cooled the Japanese market. By mid-month, expectations for an early US rate hike rose again and markets worldwide declined as they adopted a risk-off stance. The Japanese market stagnated due to the rising yen, cheap crude oil prices, and declining global stock markets. On the 21st September, the BoJ announced that it would introduce a new monetary policy and that it would not deepen negative interest rates. Long rates rose as a result and financials rallied. In the US, the Fed postponed its rate hike and the yen advanced as a result of both of these policies. At the end of the month, the market lost direction but on the 29th September, when OPEC agreed to cut oil production, resource stocks and foreign demand oriented stocks were bought. However, the market declined on the final day of the month when Deutsche Bank’s stock plunged in the US market.

The TOPIX closed the month at 1,322.8 (down 0.5% MoM) and the Nikkei 225 at 16,449.8 (down 2.6% MoM).

In terms of sector performance, 16 sectors among the 33 sectors gained. The best five performers were miscellaneous manufacturing, fishery & agriculture, oil, retail and pharmaceuticals. The worst five performers were banking, securities, transportation equipment, insurance and steel.

The yen started the month at 103.43 against the US dollar and appreciated towards 100 but ended the month at 101.35.

The yield on 10-year JGBs opened at -0.07%. At the beginning of the month, the yield rose from -0.07 towards -0.02 influenced by the rise in the US long-term rate. However, the yield fell in the latter half of the month as the possibility of a US rate hike retreated. The yield ended the month at -0.085%.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 30th September 2016 was down 1.4% compared with that of 31st August, while the TOPIX declined 0.5% during the same period. The Fund put no new names into the portfolio with no stocks sold out.

The BoJ released the long-awaited results of its comprehensive assessment following its 20-21 September monetary policy meeting and launched a new kind of monetary easing by setting a cap on the 10-year bond yield and pledging to continue to buy assets until inflation exceeds 2% in a stable manner.

Although the BoJ says there remain a number of options, such as further cuts in interest rates and additional quantitative easing to raise inflation expectations and avoid further strengthening of the yen, the Investment Adviser believes with monetary policy alone it would be difficult to achieve a 2% inflation target, and further cuts to negative interest rates are not on the agenda. The Investment Adviser thinks now is the time for fiscal policy to play an important role to reflate the economy together with continuing monetary policy support. It is most likely that the Abe administration will pass the supplementary budget for FY2016 in the Diet on 11th October as part of an economic stimulus package of 28.1 trillion yen. The Japanese economy is on course for a sound recovery. Industrial production in August increased 1.5% MoM, higher than the market expectation of +0.5%, and the government forecasts that industrial production in September will rise to +2.2% MoM, and rise further to +1.2% MoM in October. The passage of the supplementary budget in the Diet should be a strong spring board for a sharp economic recovery from the viewpoint of its size and timing. This fiscal stimulus should contribute to currency stability, and the USD/JPY is expected to move back to a level around 105-110 towards the end of 2016 as the Fed is likely to raise interest rates in December and emerging economies are entering into a stable and firm trend. The Investment Adviser thinks the Japanese stock market could advance by 15-20% towards year end, with economically sensitive stocks leading the rally. Anticipated stagnant results of corporate profits for 2Q of FY2016, to be announced from mid- October to mid-November, should be regarded by investors as the last negative factors being dispatched and should provide a good investment opportunity.

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 the real estate and construction sectors. The Fund retains a 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 12/10/16 and are based on internal research and modelling.