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Tencent News "First Line"

Author: Zhu Yuting Editor: Liu Peng

Japanese stocks led the decline in global markets. On August 5, the Nikkei 225 and Topix both fell more than 7% in early Asian trading on Monday, extending last week's sharp decline and bringing the overall decline since the July high to more than 20%. Previously, the yen appreciated sharply due to the Bank of Japan's interest rate hike last week.

As of press time, the USD/JPY exchange rate was 145.5, far lower than nearly 162 three weeks ago, prompting investors to continue covering their short yen positions.

In this regard,UBSThe Wealth Management Chief Investment Officer’s Office (CIO) released an analysis stating:In a scenario where USD/JPY remains at or above 150, we could see a rebound in Japanese stocks in the short term; in the alternative scenario, if USD/JPY is well below 150, it could take longer for investor confidence to recover.

What is the background?

On July 31, the US stock market rebounded, with enthusiasm for artificial intelligence (AI) and capital expenditures by leading technology companies pushing the S&P 500 up 1.6%, but the Japanese market failed to follow. The Federal Reserve also hinted that it could cut interest rates as early as September due to falling inflation and increased risks in the job market.

Japanese stock investors have had to contend with a surprise tightening by the Bank of Japan, a sharp fall in the dollar against the yen that could hurt Japanese exporters’ earnings and renewed concerns about a U.S. recession.

What does this mean for Japanese investors?

In the short term, UBS believes that the current Topix level is equivalent to a USD/JPY exchange rate of less than 150, but short-term market volatility should continue until the USD/JPY exchange rate stabilizes.

In the case that USD/JPY remains at or above 150, we could see Japanese stocks rebound in the short term. In the other case, if USD/JPY is well below 150, UBS believes that it may take longer for investor confidence to recover.Any signs of recovery may only emerge when Japanese companies report first-half results in October or even after the U.S. election in November.

UBS said Japanese earnings forecasts could remain under pressure if the dollar remains between 145 and 150 yen. Japanese companies assumed an average dollar-yen exchange rate of 144 in their fiscal 2024 guidance.

Weaker U.S. economic data has worried investors and heightened concerns that the Federal Reserve may cut interest rates too late, leading to a U.S. recession.

UBS believes these concerns are premature. Although the July employment report failed to meet previous expectations, non-farm payrolls increased by only 114,000 and the unemployment rate rose to 4.3%, up from 4.1% last month and a significant increase from the low of 3.4% in May 2023. Average hourly earnings increased by 0.2% month-on-month, and weekly work hours declined, indicating a negative impact on household income. However, UBS believes it is not wise to over-interpret a single report. Recent labor data may have been affected by the hurricane in Texas, making the data look worse than it actually is.

Recent data suggests that the U.S. economy is still growing, with the Atlanta Fed GDP tracker showing the economy expanding at a 2.5% pace. The Fed has also said it has the flexibility to support the economy if needed.

UBS believes the U.S. economy is heading for a soft landing, not a contraction. The Federal Reserve will cut interest rates by 100 basis points this year, most likely with a 50 basis point cut in September, to avoid a U.S. recession and keep growth close to its trend of 2%.

How can Japanese investors adjust their portfolios?

After a steady rise until mid-July, U.S. stock market volatility is increasing. The upcoming Fed rate cut cycle, continued focus on the development of artificial intelligence, and rising political uncertainty ahead of the November U.S. presidential election mean thatJapanese investors should prepare for a new round of volatility but should avoid overreacting to short-term market changes.

Against this backdrop, UBS recommends Japanese investors consider the following strategies:

Seeking high-quality growth

Focus on investing in companies with strong competitive advantages and sustained growth. Many Japanese companies have these qualities in areas where Japan is particularly competitive.

UBS believes these companies are likely to continue to perform well, particularly as beneficiaries of long-term structural reforms such as changes in corporate governance, the re-emergence of sustainable inflation and positive real wage trends.

UBS remains bullish on bank and real estate stocks, while some Japanese exporters may remain choppy as USD/JPY volatility remains elevated. Structured strategies that provide capital protection can help investors retain equity market exposure and participate in a potential rebound while reducing the risk of being affected by further consolidation.

Seizing the opportunity of artificial intelligence

UBS continues to be optimistic about the growth of artificial intelligence.Fundamentals remain solid, with global technology companies expected to post 24% year-over-year earnings growth in the second quarter. Overall capital expenditures by large technology companies are expected to grow 43% year-over-year in 2024, following previous guidance of an additional $9 billion, and there is more anecdotal evidence that AI monetization is accelerating.

The latest earnings and recent supply chain checks also point to strong demand for AI chips in the coming year.UBS believes that the recent stock price correction has made valuations more reasonable, which is a good opportunity to increase positions in leading artificial intelligence beneficiaries in the semiconductor, software and Internet sectors.Investors may also consider structured strategies to gain more defensive exposure to volatility ahead of the U.S. election.

Diversify with alternative assets

Long-term investors may consider investing in hedge funds and private equity to seek new sources of returns and potentially reduce volatility in portfolio value.Some hedge fund strategies, such as multi-strategy and macro funds, can find investment opportunities even in volatile markets by diversifying investments across different types of managers, strategies and asset classes. However, it is important to remember that investing in alternative assets comes with risks, including illiquidity and less transparency.

By following these strategies, UBS said it believes Japanese investors can navigate the current market volatility and position themselves for potential opportunities in the future.