Semiconductor drought will drive the market

Market Development: The Japanese market rose at the beginning of November, following a sharp correction the previous month, but it eventually declined on the back of the discovery of the Omicron variant.

Fund Commentary
13 Dec 2021

Market Development: The Japanese market rose at the beginning of November, following a sharp correction the previous month, but it eventually declined on the back of the discovery of the Omicron variant.

The primary drivers of the market appreciation were the Electronics and Precision Instruments sectors. These are safe-haven sectors that are outside of the broader industries that face the possibility of a severe economic downturn caused by higher oil prices and weak domestic consumption.

Oil prices had a direct impact on domestic and international logistics. The higher input costs are transferred to products or absorbed by producers so that there are no shortages of goods, foods and other daily items. Meanwhile, the semiconductor shortage has not been resolved, resulting in Toyota’s car production in October declining by 25% compared to the previous year.

In addition to the Automotive industry, electronics and associated peripheral manufacturers are also experiencing a shortage of digital and analogue devices. This has pushed the top-line growth of semiconductors and semiconductor manufacturing equipment makers, increasing the number of backorders.

Market Outlook

We are unsure about the Omicron variant at this point. It is said that it has a higher infection rate than the delta variant, but a lower mortality rate. This said, the new variant could shut down the world economy, so people may face further inconvenience within their lives.

Japan has shut down ports and limited foreign visitors, and Japanese citizens have been asked to stay at dedicated places for a certain number of days to prevent Omicron from spreading. It is inevitable that the domestic economy will decelerate for a while and we have to prepare for a possible economic downturn in early 2022 due to the unforeseen impact of the Omicron variant.

People will be asked to stay home and keep voices down for the immediate future. It is also likely that people will be hesitant towards travelling abroad again and we believe they will spend money on luxury goods such as cars, electronic gadgets and branded goods instead.

In this context, EV demand is unlikely to slow in 2022 and carmakers will significantly increase their efforts to procure electronic devices. Domestic and international logistics are not only an issue for auto production, but also for manufacturers in many other industries.

Car manufacturers, for example, will pay higher input costs (procurement of devices and raw materials). These costs will then be reflected in the price of the final products, or absorbed by the manufacturers, impacting profitability.

We expect end consumer pent up demand for cars and electronic gadgets to rise in 2022, benefitting device makers if logistical headwinds can be overcome. We will continue to focus on semiconductors and their raw materials.

In addition to the above industries, we will prioritise Digital Transformation (DX) equipment and service companies, as every company needs to improve productivity in order to absorb the non-passable costs of products.

Portfolio Development

Nippon Denkai (5759) manufactures and sells high-quality electrodeposited copper foils for printed circuit boards, industrial usage and energy storage applications. The company has production facilities in Japan and the US. We believe such products, combined with a global manufacturing base, will be well received by global EV and other electronic device makers.

Mec (4971) performed well over the month and contributed positively to the portfolio’s return. Mec engages in the production and sale of chemicals, equipment and related materials used in the production of printed circuit boards. It offers chemicals for electronic substrates and resin to metal bonding technology. The company announced its Q3 earnings in early November and recurring profit has progressed by 84% of the company’s annual profit target.

As always, we invite investors, or prospective investors in the Strategic Japan Opportunities Fund to discuss the opportunities with the investment team if they would like to understand our views on the current situation and the positions held in the portfolio. Please do not hesitate to contact Adam or visit the Fund Page >

Adam TurbervilleAdam Turberville
Director
+44 1481 742380
a.turberville@ericsturdza.com

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The views and statements contained herein are those of Rheos Capital Works Inc in their capacity as Investment Adviser to the Fund as of 07/12/2021 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.