24 February 2020
Concern over upcoming Tokyo Olympics
‘Shiranu ga hotoke’ or ‘Ignorance is bliss’. So says the old Japanese proverb…but in this age of instant news, ignorance is hard to come by – and didn’t Japan know it last week!
The country came under criticism for its quarantining of the Diamond Princess cruise ship near Yokohama, as 100 passengers were infected with Coronavirus (now known as COVID-19) and three passengers died. This came amid speculation over whether the Tokyo Olympics will be able to go ahead this summer; some commentators went so far as to hazard that London might end up hosting the games instead. One sporting event in the epicentre of the virus outbreak has already been postponed – the World Indoor Athletics Championships, which were due to take place in China next month.
Japan falls towards a technical recession
The economic benefits of hosting the Olympics are a subject of debate, but Japan could undoubtedly do with a short-term boost. Last week, fourth quarter results in the country showed a 1.6% plunge versus the previous quarter – or a stunning 6.3% annualised. The country is probably falling into a technical recession (defined as two consecutive quarters of negative growth). Interest rates are at -0.1% and the government has already announced fiscal stimulus, meaning fiscal and monetary response options may be limited.
So, is the growth dip down to a recent sales tax hike, or is something more fundamental at play? Yoshihiko Ito of Nippon Value Investors, Manager of the St. James’s Place Japan fund, believes it’s a combination of factors:
“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. 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.”
Last week, the TOPIX index in Tokyo endured a choppy seven days of trading, and ended down – its trajectory contrasting with the FTSE 100 and Shanghai Composite, which finished the week in the black, although the S&P 500 ended down. While global equities suffered at times last week, they 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. 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. As a result, the company’s business is less sensitive to economic 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.”
Coronavirus strikes global stocks
Of the major stock markets outside China, Japan may be particularly sensitive to COVID-19 developments, but the West is hardly shielded. Last Thursday, the S&P 500 took a sharp fall. One cause was Apple’s earnings announcement, in which the company reported a reduction in its quarterly sales target due to slower iPhone production and weaker demand in China, both as a result of the virus. More directly, the index was afflicted by news of new COVID-19 deaths in South Korea, Iran and Italy. With a few weeks of rising infection numbers now behind us, is it now possible to make meaningful forecasts?
Kieran O’Connor of Rowan Dartington commented:
“There are average anecdotal consensus forecasts of a 2% impact on annualised Chinese economic growth projections of 6%. 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. There will be a longer-lasting dip in bookings in the hotel and leisure industries, especially Asia-bound cruises – and the airlines and Hong Kong will be off the tourist circuit for some time, having already been impacted by the free speech protests last year.”
Beijing last week responded to the economic fallout by cutting a benchmark lending rate (the one-year loan prime rate, to be precise) 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 fall to 4.4%, should the outbreak not peak until April, but offered a likely scenario of 5% growth.
US shows signs of hope
With the world’s second-largest economy facing huge pressures, the third largest apparently falling into recession, possibly followed by the fourth (Germany), investors are turning increasingly to the US for signs of comfort. Thankfully, there are a few to be had: the Philadelphia Fed regional manufacturing report, the Conference Board Leading Economic Index, US jobless claims, Bloomberg’s economic expectations index, residential construction trends, mortgage applications, the Citi Economic Surprise Index, and factory activity indices all offered encouraging data.
Finally, there were some boosts on home soil, as inflation, manufacturing orders, employment numbers, and Purchasing Managers’ Indices all ticked up in the UK.