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WeekWatch 24/02/2020

WeekWatch 24/02/2020

‘Ignorance is bliss’, goes the old Japanese proverb – or, translated literally, ‘not knowing is Buddha’. In this age of statistical overload, such ignorance is hard to come by, and didn’t Tokyo know it last week.

The Japanese government came under pressure for its quarantining of the Diamond Princess cruise ship near Yokohama, as three passengers died of the new coronavirus (now known as COVID-19) and some 100 passengers were infected. The deaths came amid speculation over whether the country can prevent the virus from ruining – or even ruling out – the Tokyo Olympics this summer; some commentators went so far as to speculate that London might end up hosting the games instead. (The World Indoor Athletics Championships, which were due to take place in Nanjing, China next month, have already been postponed.)

The economic benefits of hosting the Olympics are disputed, but Japan could do with a short-term boost. Last week, fourth quarter results showed a 1.6% plunge versus the previous quarter – or 6.3% annualised. The country is probably falling into a technical recession (i.e. two consecutive quarters of negative growth). Interest rates are at -0.1% and the government has already announced fiscal stimulus – fiscal and monetary response options may be limited. Is the recent sales tax hike to blame, or something more fundamental?

“The decline appears largely due to the shrink in consumer spending in response to the consumption tax rate increase from 8% to 10% in October, after a surge in demand before the tax rate hike during the previous quarter,” said Yoshihiko Ito of Nippon Value Investors, manager of the St. James’s Place Japan fund. “Unusually warm winter weather and uncertainty over the US–China trade dispute is expected to continue weighing on the world economy – as is the new coronavirus.”

The TOPIX index in Tokyo endured a choppy week and ended down: its trajectory contrasting with the S&P 500, FTSE 100 and Shanghai Composite, all of which finished the week in the black. However, global equities have largely recovered from the COVID-19-induced falls they suffered earlier in the year. Japanese stocks, on the other hand, are below where they opened 2020 – have investors been wise to sell?

“We have recently been buying Aica Kogyo, which manufactures chemicals and building and decorative materials,” said Nippon’s Ito. “It has a domestic market share of more than 70% for melamine decorative wall panels, which are used for replacing tile and PVC materials in public and commercial buildings. The company’s business is less sensitive to cycles – consistent sales and earnings growth can be expected.”

That selectivity may be crucial in the coming months, given Japan’s high exposure to China’s economy – and reliance on both Chinese tourists, who are sitting tight, and Chinese factories, many of which are closed. However, Capital Economics argued last week that, while the economy is likely to contract by around 0.2% this year, financial assets in Japan should be relatively well insulated.

“Monetary policy in Japan is already very loose and concerns about the effect of further easing on the financial sector are likely to stay the Bank of Japan’s hand. Indeed, at its last meeting the Bank explicitly said that it is willing to look through a temporary period of slower growth. Investors have also gradually come round to our view that Japan’s monetary policy settings will remain unchanged. We think that the yield of 10-year Japanese government bonds and the yen will end 2020 … roughly where they are now.”

Among major stock markets outside China, Japan may be particularly sensitive to COVID-19 developments, but the West is hardly insulated. Last Thursday, the S&P 500 took a sharp fall. Part of the impetus was Apple’s earnings announcement, in which the company reported a cut in its quarterly sales target on slower iPhone production and weaker demand in China, both due to the virus. COVID-19 deaths in South Korea and Iran didn’t help either. With virus trends now emerging, is it now possible to make meaningful forecasts?

“There are anecdotal consensus forecasts of a 2% impact on annual Chinese economic growth projections of 6%,” said Kieran O’Connor of Rowan Dartington. “The impact will reverberate around the world and have an impact on the earnings of many businesses that will run short of components in manufacturing industries, textiles in the clothing industry and high-volume retail items such as toys and electronics.

Beijing last week responded to the economic fallout by cutting a benchmark lending rate by 0.1%, just as Standard & Poor’s warned that COVID-19 meant Chinese banks faced a rise of up to $1.1 trillion in bad loans. It forecast 2020 growth in China could even fall to 4.4%, should the outbreak not peak until April.

So, in summation, the world’s second-largest economy is facing huge pressures, while its third-largest, Japan, is apparently falling into recession. As for its fourth-largest, German data released last Tuesday suggests a recession may be under way there, too (and wider eurozone growth has slowed almost to a halt). Furthermore, last week saw India rise to become the world’s fifth-largest economy, according to World Population Review but, even there, the recent growth slowdown has been pronounced.

Amid such grim signals, investors are turning increasingly to the US for signs of hope and, thankfully, there are a few to be had – among them, the Philadelphia Fed regional manufacturing report and US jobless claims. Finally, there were some boosts across the Atlantic too, as inflation, manufacturing orders, employment numbers, and Purchasing Managers’ Indices all ticked up in the UK.

FSSA and Schroders are fund managers for St. James’s Place.

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