The market is waiting for a clear signal to make a significant jump

BY YUTAKA UDA

Monthly Fund Commentary
25 Jun 2018

BY YUTAKA UDA

During the first half of May, the Japanese market gained as optimistic views prevailed on the back of solid company results and a depreciation of the yen following a rise in both, the crude oil price and the US long-term yield.

During the month, the TOPIX declined for 8 consecutive days on the back of geopolitical risks associated with 1) North Korea, 2) global trade frictions, and 3) the economy in Southern Europe. Overall, the risk-averse market triggered an appreciation of the yen, whereas the market itself ended the month with a loss.

In early May, the Japanese market proved quite optimistic, prepared to buy equities after the Golden week vacation, when most company results were announced. During the same period, the market moved within a fixed range, swayed by company results and announcements related to repurchase programs.

In mid-May, the market gained from a depreciation of the yen, following a rise in the crude oil price and the US long-term yield, which surged above the closely watched 3% threshold. On 16th May, the market dipped after preliminary GDP data for the period Jan–Mar was announced, indicating negative QoQ growth for the first time in 9 quarters. The yen continued to depreciate and together with better than expected Jan-Mar machinery orders and an upbeat Apr-Jun forecast, pushed the market higher. Against this backdrop, the Nikkei 225 surpassed 23,000 on 21st May, a level not reached since 2nd February. Shortly after, the TOPIX declined for 8 consecutive days until 30th May – marking the first prolonged decline since the Abe administration took office in 2012 – following Trump’s announcement that he was cancelling the US-North Korea summit, and possibly introducing tariffs on automotive imports towards the end of the month. 

A plunge in Italian government bonds further triggered a risk-off mood in the market.

The TOPIX closed the month at 1,747.5 (down 1.7% MoM), while the Nikkei 225 finished at 22,201.8 (down 1.2% MoM). In terms of sector performance, only 9 out of 33 sectors gained. The best five performers were services, chemicals, glass and ceramics, land transportation and fishery, while the worst five performers were mining, marine transportation, non-ferrous metals, securities, and pulp & paper.

The yen started the month at 109.34 against the US dollar and moved in a range around 109/dollar until mid-month, after which the yen slowly depreciated, reaching 111.4 on 21st May. Later in the month, when the risk-off mood became dominant, the yen appreciated, following the prevalence of geopolitical risks and a plunge of Italian government bonds. The yen ended the month at 108.82.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 31 May 2018 lost 4.5% compared with that of 27 April, while the TOPIX declined 1.7% during the same period. The Fund put no new names into the portfolio with two stocks (Nissan Motor and Yamada Denki) sold out.

Although economic activity in Q1 2018 was slightly disappointing due to bad weather in Japan and emerging geopolitical risks around the world, it appears that the economic situation is improving in Q2. Industrial production, which recorded its first QoQ decline (-1.3% in Q1 2018) in the past eight quarters, rose 0.3% MoM, with shipment up 1.8% MoM and inventory down 0.4% MoM in April. The government estimates that industrial production would rise 0.3% MoM in May and decline 0.8% MoM in June. If the forecasts are correct, industrial production will rise 1.8% QoQ in Q2. Core machinery orders (excluding ships and electric power companies), a leading indicator of capex, rose 3.3% QoQ in Q1 2018, up from 0.3% QoQ in Q4 2017. According to a survey of the order outlook, core machinery orders are expected to rise sharply, by 7.1% QoQ. External machinery orders, a leading indicator of capital goods export, are expected to grow 11.2% QoQ in Q2 after a decline of -1.7% QoQ in Q1.

Besides the above, further economic data appears encouraging. According to Nikkei’s survey, capital expenditures in FY2018 for all industries (including companies with more than JPY100 million paid in capital (excluding financials)) is expected to increase 16.7% YoY, thereby superseding FY2017 results, which indicated a 4.7% increase. According to the survey, the manufacturing sector will increase capex substantially with an increase of 18.7% YoY, while non-manufacturing sectors will also gain, rising 14.0% YoY. Whether these forecasts will materialise or not depends, amongst others, on developments with regard to trade frictions, geopolitical risks, and currencies.

The fact that Japanese companies are taking a much more positive stance on capex, is clearly good news. In terms of corporate profits, recurring profits of companies in the Russell/Nomura Large Cap Index (excluding financials) increased 17.5% YoY in FY2017, and are expected to rise 8.7% YoY in FY2018, based on a yen/dollar exchange rate of 106.

The month of June will be a critical month for the stock market as there are many important events coming up such as the G7 summit, the US-North Korea summit, FOMC, BoJ’s monetary policy meeting, OPEC meeting and Japan’s new growth strategy. The market is currently waiting for a clear signal to make a significant jump, following improving economic fundamentals and cheap valuations.

The Fund is increasing its allocation to energy-related sectors such as oil and trading companies together with cyclical sectors such as steel, non-ferrous metals and chemicals, since infrastructure demand should support or lift global economic growth. The Fund retains a positive stance towards banks and machinery stocks, while 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 08/06/18 and are based on internal research and modelling.