Strong upside potential beyond political instabilities


Fund Commentary
18 Jan 2016


The Japanese market declined in December as a result of 1) risks to the global economic outlook, represented by declining crude oil prices and 2) the appreciation of the JPY against the US dollar. In early December, the market started in a brisk mood. On the 1st December, all-industry capex for Jul-Sep was published at + 11.2% YoY and this pushed the Nikkei 225 above 20,000 for the first time since August. However, on the 4th December the market started to decline in tandem with other global markets as the easing measures announced by the ECB on the 3rd December fell short of investors’ expectations.

The decline in crude oil prices put further pressure on global markets as concerns arose for the global economic outlook. On the 16th December, when the Fed decided to raise interest rates for the first time in 9 and 1/2 years, the Japanese market rose with other markets. However, this did not continue for long as crude oil prices declined further. The Japanese market also became volatile when the BOJ decided to maintain its monetary policy and the government decided on a JPY3.3 trillion supplementary budget on the 18th December, which was first taken positively but later disappointed the market as it was not perceived as further easing. At the end of the month, investors went fishing for cheap stocks and stock prices became rather more stable. Domestic economic numbers were mixed, as the labour market remained tight and the number of inbound visitors continued to show record highs, while consumption in November showed weakness.

The TOPIX closed the month at 1,547.3 (down 2.1% MoM) and the Nikkei 225 at 19,033.7 (down 3.6% MoM). In terms of sector performance, 24 out of the 33 TSE sectors fell. The top five performers were fishery & agriculture, air transportation, foods, pharmaceuticals and land transportation. The worst five performers were other products, pulp & paper, securities, metal products, and rubber. The JPY started the month at 123.11 against the US dollar and appreciated towards 120.22 by the end of month.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 30th December 2015 decreased 3.1% compared with that of 30 November, while the TOPIX declined 2.1% during the same period. The Fund put no new names into the portfolio with no stocks sold out.

World stock markets started the New Year on a very weak note triggered by weak economic data both in China and the USA. Continuous devaluations of the Chinese currency (renminbi) against the US dollar have led investors to speculate that Chinese economic conditions could be worse than reported. Escalating tensions between Saudi Arabia and Iran, and North Korea’s nuclear test have exacerbated political instabilities across the world.

Regarding the devaluation of the renminbi, the Investment Adviser suggests the renminbi has been too strong against many currencies such as the euro, yen and emerging economies’ currencies due to its peg system to the US dollar. In that sense, it might be expected that the Chinese authorities were tempted to devaluate the renminbi against the US dollar in order to regain China’s industrial competitiveness against other countries which are seeing softening economic growth. But the Investment Adviser reiterates that China still has many options at their disposal which could stimulate the real economy and the market. The Investment Adviser hopes that this world market turbulence will be settled within a couple of weeks.

In the meantime, the Japanese economy is in better shape. Industrial production in November declined 1.0% MoM, worse than consensus of -0.5% MoM, but the government estimated that it would increase 0.9% MoM in December, and increase 6.0% MoM in January 2016. Therefore, it is expected that industrial production in 4Q will rise 1.4% QoQ, and might have a chance of increasing to 5.0% QoQ in 1Q 2016. The labour market is continuing to tighten with the job offers to applicants ratio in November increasing to 1.25X, the highest since January 1992. At the New Year party, Mr. Sakakibara, the Chairman of Keidanren (the employers federation of economic organizations), made a call to members for higher wage hikes in the 2016 spring negotiation, after a 2.5% rise in 2015. The supplementary budget with JPY3.3 trillion to stimulate the economy is expected to pass in the Diet in the middle of January.

Net exports are expanding as manufacturers are steadily increasing reshoring of their operations, energy imports are declining partly due to the steady increase of nuclear power generation. Sharp increases of capex are on the agenda, and consumption may recover in line with higher wage hikes. The Investment Adviser believes Japan is well situated to be able to grow 2.0-2.5% for FY2016 in real terms with corporate profits expanding more than 10% YoY. The market should start to show a remarkable rally once international uncertainties are stabilised.

Construction and real estate sectors are expected to show another strong rally with replacement demands expanding sharply and 2020 Tokyo Olympics related projects starting. The Fund is increasing its allocation to the machinery and IT service sectors with the conviction that capex will have to grow to seek higher productivity. The Fund will also maintain high weightings in banks and commerce (mainly trading companies) sectors. On the other hand, defensive and hardware technology sectors should be avoided as these have high valuations and lower growth potential.

The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Fund as of 13/01/16 and are based on internal research and modelling.