WHAT NEXT FOR CHINA AND JAPAN? /
Japanese companies are exposed to a potential recession in Russia, writes Matein Khalid
After a fabulous 2013, Japanese equities returns have been more muted in 2014. Japan Inc reported Q1 earnings well above consensus, despite the drag from the consumption tax and the Arctic winter growth downtick in the United States. As the strong banking earnings demonstrate, domestic demand in Japan and export demand was resilient, even though Japanese companies are exposed to a potential recession in Russia, the EU and slower growth in China. The Q1 results, banking profit surge and a rise in dollar-yen to 104 suggests that consensus forecasts could still rise in Japan. In any case, the earnings revision index for Tokyo Stock Exchange firms turned positive in June, thanks to global cyclicals, such as Japanese steel, auto, chemical and electronics appliance firms.
It is only natural that exporters were the biggest winners in the high-beta, yen-depreciation, thin-volume-driven Nikkei rally since mid August. After all, Japanese metal, auto, electronics and machinery sectors reported 15-20 per cent earnings growth.
The yen, domestic growth, wages and structural reform (the proverbial third arrow of Abenomics!) will determine the next twist in the saga of the Nikkei Dow and Topix. I believe the Bank of Japan will accelerate its QE this winter to meet Governor Kuroda’s two per cent target, the reason the yen can fall to 106-107
China’s property market bust will obviously wreck havoc on consumer, bank and local govt balance sheets
by November. However, the real catalyst for Japanese equities is structural/shareholder reform to boost corporate earnings growth and RoE. At 1,285, I believe the Topix is overbought relative to fundamentals. I would feel far more comfortable reentering Japan if the Topix trades at 1,240-1,250. The real money in Marounuchi will be made in stock sector picking, not index positioning. My bias is to banking (Sumitomo Mitsui), autos (Toyota Motors), Internet (Yahoo Japan, Softbank) and metals (Nippon Steel).
Chinese stock markets were a disaster in the past three years, as the Politburo cracked down on speculative excesses and the world financial markets speculated that soft data/anti corruption drive/shadow banking system stresses presaged a hard landing. All this changed in May 2014, when Chinese equities did a bullish Rip Van Winkle. Every sector in MSCI China is higher since June, clear evidence of a valuation rerating — and offshore fund allocations to China rose in both July and August. Liquidity flows, cheap valuations (Chinese banks trade at post-Lehman October 2008 valuation metrics), fall in Shanghai money market rates and optimism over reform of the People’s Republic’s 143,000 state-owned corporates were the reasons for China’s amazing breakout in May 2014. However, while growth data has softened since July, industrial/energy profit growth has risen in both June/July, as did export growth.
China’s property market bust will obviously wreck havoc on consumer, bank and local government balance sheets. Chinese provincial land sales revenue have plunged since late 2013, a leading indicator of financial distress. China’s August PMI has also softened to 50.3, below the Bloomberg/Wall Street consensus. This “macro angst” could lead to a five-to-eight per cent correction in MSCI China. However, I still believe “buy on dips” is the right strategy on Chinese equities this winter as MSCI China is still inexpensive at nine times forward earnings, earnings momentum is trending higher and the Politburo has initiated both fiscal and monetary easing to avoid a hard landing. China’s iShares FTSE China 25 Index Fund rose from 34 in mid May to 41.5 in mid August.
There are some dark clouds in China. Morgan Stanley has downgraded Macau shares. Iron ore prices have fallen below $90 per metric tonne. Country Garden announces a secondary share offering at a 30 per cent discount, grim news for developers. It would not surprise me to see FXI fall to 39, a possible but not optimal entry point.