The turning point should be coming soon


Fund Commentary
18 Feb 2016


Japanese equities declined sharply, more than most other major markets in January. In addition to concerns about falling crude oil prices, an economic slowdown in China and other geopolitical risks, Japanese economic numbers were mixed which cast a shadow on earnings. Machinery orders for November fell 14.4% MoM and real spending in the December household survey fell 4.4%. On the other hand, the number of visitors to Japan in December was at another seasonally adjusted annualized all-time high of 23.1 million which is a 43% increase YoY, and the job offers to applicants ratio rose to 1.27x which is the highest level in 23 years.

The Japanese market declined for 6 consecutive days after the market opened for the New Year, which is unprecedented in the post war era. This was partially because the Japanese market held up relatively well in 2015 and partially because the JPY appreciated rapidly against the US dollar. As the WTI crude oil price fell to a 12-yr low at almost USD26.5/ bbl on 20th January, the TOPIX fell to almost 1,300 and Nikkei 225 almost to 16,000 representing a 15.9% and a 15.7% YTD decline respectively. However, on 21st January, expectations for further ECB easing arose and this supported global equity markets. When the BoJ announced the adoption of negative interest rates on 29th January, which was a huge surprise, the market bounced back. The TOPIX closed the month at 1,432.1 (down 7.5% MoM) and the Nikkei 225 at 17,518.3 (down 8.0% MoM) regaining nearly half the losses from January’s lows.

Stocks with low fundamental beta and low volatility outperformed the market. In terms of sector performance, 30 out of the 33 TSE sectors fell. The top five performers were rubber, air transportation, foods, fishery & agriculture and warehousing. The worst five performers were marine transportation, banks, electricals, insurance and steel.

The JPY started the month at 120.22 against the USD and quickly appreciated towards 116.94 on 20th January when crude oil prices reached their lows but depreciated back to 121.14 after the BoJ’s announcement.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 29 January 2016 fell 9.6% compared with that of 30 December 2015, while the TOPIX declined 7.5% during the same period. The Fund put one new name (Shimadzu) into the portfolio with no stocks sold out.

There is significant volatility in the market at present. Its chief contributors are weak oil prices and Chinese economic conditions. In terms of oil prices, according to an oil expert, although the sanctions against Iran were waived in January, Iran’s production increase could be 0.6 million bbl/d in 2016 and while the other OPEC countries are expected to hold current levels, the US may be forced to cut their production by at least 0.5 million bbl/d. On the other hand, world oil demand is expected to expand 1.2-1.4 million bbl/d. Therefore the gap between supply and demand will become quite narrow. The Investment Adviser estimates the oil price will rise to USD40-50/bbl at the end of 2016 from the current level of USD30/bbl. The price of resources such as oil, copper and iron ore look to have fallen too far, to unsustainably low levels as most suppliers are now making losses.

Regarding China, it appears that investors are too cautious regarding Chinese economic growth. It would be understandable if Chinese authorities were tempted to devalue the renminbi against the USD to some extent. The Chinese government has clearly set the target GDP growth for 2016-2020 at more than 6.5%. The Investment Adviser thinks this can be achieved since China still has many options at its disposal to stimulate its economy. For instance, their interest rates are currently at 4.35%, much higher than the CPI of 1.5%, and fiscal conditions are much healthier than
in Europe, the US and Japan.

The Japanese economy is improving. Industrial production in December declined 1.4% MoM, but in 4Q increased 0.6% QoQ, the first rise since 1Q 2015. The government estimates that industrial production in January will rise 7.6% MoM and decline 4.1% MoM in February. The estimates show choppy data on a monthly basis, but industrial production is expected to grow rather sharply from 1Q onwards as inventory adjustments in the auto industry are almost complete by 4Q 2015 with many new models being released from 1Q 2016. Additionally, the supplementary budget with 3.3 trillion yen for FY2015 will start to contribute to the economy from 1Q. 

The Investment Adviser believes the market should start to show a remarkable rally once international uncertainties are stabilised. At present defensive sectors are doing relatively well, as they did last year. But the turning point should be coming soon. It would not be surprising if the market rose notably higher from here by the end of 2016. The market leaders should change dramatically from defensive sectors to economically sensitive domestic sectors.

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 12/02/16 and are based on internal research and modelling.