Infrastructure spending will help the global economic recovery

On the 1st February, Japanese equities fell following a decline in China’s manufacturing PMI. This said, solid US economic numbers relating to payroll data and the ISM Manufacturing Index were announced the same Friday, leading the Japanese market to recover the following week.

Fund Commentary
25 Mar 2019

On the 1st February, Japanese equities fell following a decline in China’s manufacturing PMI. This said, solid US economic numbers relating to payroll data and the ISM Manufacturing Index were announced the same Friday, leading the Japanese market to recover the following week.

In early February, many Japanese companies announced Q3 earnings results, leading the market to sway accordingly. Forecasts were subject to material downgrades, but share buybacks and strong results, alongside a depreciating Yen against the US Dollar bolstered the market.

From mid-February onwards, US-China trade discussions took place almost every week. From the 18th onwards, the Japanese market surged for four consecutive days on signs that the US attempted to avert the closure of government agencies and make progress regarding trade talks with China.

A rise in Chinese equities also bolstered the domestic market. The Risk on market strengthened the US Dollar against the Yen, further aiding the Japanese market, which moved fairly steadily in late February.
Towards the end of the month, the Dow surpassed the 26,000 level, whilst the crude oil price exceeded 57 Dollars for the first time since last November. Geopolitical risks arose in India / Pakistan, leading the Yen to appreciate. On the last day of the month, the market declined on the back of Japan’s weak industrial production index and China’s manufacturing PMI.

The TOPIX closed the month at 1,607.7 (up 2.6% MoM), with the Nikkei 225 finishing at 21,385.2 (up 2.9% MoM). In terms of sector performance, 28 out of 33 sectors gained, with the five best performers being precision instruments, communication, pharmaceuticals, services and warehousing. The five worst performers were oil, miscellaneous manufacturing, marine transportation, banks and real estate.

In February, the Yen weakened against the US Dollar over confidence in global markets. The Yen started at 108.89 against the US Dollar, ending at 111.39. The yield on 10-year JGBs started at 0.005, temporarily dipping to -0.05 when BoJ’s Governor Kuroda mentioned the possibility of additional easing, should the Yen become too strong. A rise in the equity market suppressed the increase in JGBs, which ended the month at -0.022.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese Yen basis as of 28 February 2019 rose 0.2% compared with that of 31st January, while the TOPIX gained 2.6% during the same period. The Fund put no new names into the portfolio with five stocks (Shimadzu, SCSK, Kobe Steel, Toyota Motor and Mizuho Financial) sold out.

Market Outlook

Uncertainty over trade talks between the US and China, the lack of direction on the Brexit deal, and the impact from a prolonged partial shutdown of the US government had a negative impact on Japanese economic data for the month of January. Industrial production declined 3.7% MoM, with the government estimating that it would rise 5.0% MoM in February and subsequently decline by 1.6% MoM in March. After a sound recovery of +1.9% QoQ in Q4 2018, it is likely that industrial production will show negative QoQ growth in Q1 2019 according to the Investment Adviser. Core machinery orders declined 5.4% MoM in January, much worse than the market consensus of -1.5% MoM, although data tend to be volatile. It appears that the market has discounted short term uncertainty to a great extent. The Investment Adviser thinks that the turning point is approaching and that the world economy needs a new stimulus to stop a further slowdown.

In the National People’s Congress in Beijing, which started on 5th March, China’s Premier Li Keqiang announced that China would aim for economic growth of 6.0-6.5% in 2019, down from its target of 6.5% over the past two years. In order to keep the relatively high growth levels, China committed to easing its monetary policy and implementing aggressive fiscal stimulus. For instance, the quota for local governments to issue bonds to fund infrastructure projects will rise by RMB 800bn (USD 119bn), an increase of almost 60% YoY.

In the US, President Trump unveiled a record budget of USD 4.7tn for FY2020, constituting a ca. 5% increase over the previous year. The budget is designed to raise military spending and cater for the building of the Mexican border wall. Trump also proposed to spend USD 200bn on the country’s infrastructure over a time frame of 10 years. People argue that the White House budget faces strong obstacles, as the Democrats now control the House of Representatives.

In Japan, the government is likely to pass an aggressive budget for FY2019, allocating JPY 101.5tn (up 3.8% YoY) in the Diet by the end of March 2019 in addition to two sizeable supplementary budgets for FY2018. The team believe that the US and China will find meaningful solutions regarding the trade dispute within a couple of months, and that global infrastructure spending will help bolster the global economic recovery.

Portfolio Strategy

Against the backdrop of Japan’s vulnerability against natural disasters and sizeable fiscal spending, which has been under discussion since November 2018, the Investment Adviser is increasing the weighting in the construction and real estate sectors. The Fund continues to be overweight with regards to economic sensitive sectors such as energy, trading companies, banking and machinery. 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 13/03/2019 and are based on internal research and modelling.