05 November 2019
Global investors could be forgiven for being more familiar with Japan’s risks than its opportunities. Japanese stocks have faced multiple headwinds this year, as uncertainty over US-China trade tensions and the resulting drag on the global economy have clouded the outlook for corporate earnings.
Despite these challenges, Japan’s economy remains relatively stable, and growth rates in the first half of the year surpassed market expectations. The analyst revision index has already reached its typical bottom and we expect earnings to stabilise in the coming quarters, even as share prices are likely to remain volatile amid geopolitical concerns. But looking beyond the macro challenge, we see some technology-related companies that are well-positioned to take advantage of the structural changes underway.
A mixed macro backdrop
Japan is so far weathering global uncertainties. Confidence among Japanese manufacturers has clearly weakened, but sentiment in the non-manufacturing sector has held up. Employment conditions remain tight and capital expenditure plans are bolstered by non-cyclical factors, such as investment in labour-saving technology. The Bank of Japan remains in highly accommodative mode and extensive counter measures are being deployed to mitigate the effects of October’s consumption tax hike.
Against this mixed macroeconomic backdrop, there has been a clear bifurcation in corporate earnings between the manufacturing and non-manufacturing sectors. In most global cyclical industries, company results have been generally worse than analyst estimates, with earnings declining sharply. Conversely, some non-manufacturing companies have posted solid earnings growth.
While we might see more Japanese manufacturers announce downward revisions to their full-year guidance at the interim stage, especially if the yen appreciates further, we expect aggregate earnings to rise year-on-year in the second half of the fiscal year through March 2020, given the relatively low base comparison with the previous year.
Identifying investment opportunities in the technology cycle
Trade frictions have coincided with a downturn in the technology cycle. Semiconductor stocks fell by about 50 per cent from their peak in late 2017, but we are now coming out of a negative inventory and supply cycle, and memory prices are expected to stabilise. Specifically we think prices of NAND flash memory chips for long-term data storage will stabilise in the second half of 2019, and prices of DRAM (dynamic random access memory) chips in the first half of 2020. Earnings should reach a bottom in the next quarter or two.
Looking ahead to 2020, we expect a re-acceleration of demand for memory semiconductors, driven by content growth from the global rollout of fifth-generation (5G) smartphones as well as a recovery in spending by data centres. Memory supply/demand will tighten as new capacity additions were controlled over the past one to two years.
In this environment, market dynamics combined with overly negative sentiment have created opportunities to buy companies at trough valuations. For example, as the inventory cycle of electronic components and devices bottoms out, some globally competitive companies are well-positioned to capture the structural growth for automotive semiconductors.
The advent of 5G handsets will create a new content cycle for globally competitive component makers even if the overall economic environment is not accelerating. Our meetings with supply chain companies suggest that 5G penetration will be higher than street estimates.
The disconnects between sentiment and fundamentals
Given the uncertainty facing the global economy and with Japanese valuations testing historical lows in some parts of the market, we can find opportunities in the disconnects between near-term sentiment and mid-term fundamentals.
We think technology-related stocks in Japan offer a rich source of ideas, especially for investors who focus on companies that can grow across cycles by embracing internal transformation and capitalising on labour shortages and other structural changes.
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