Live from the Morgan Stanley Japan Summit, our analysts Chiwoong
Lee and Sho Nakazawa discuss their outlook for the Japanese
economy and stock market in light of the country’s evolving trade
partnerships with the U.S. and China.
Read more insights from Morgan Stanley.
----- Transcript -----
Lee-san: Welcome to Thoughts on the Market.
I’m Chiwoong Lee, Principal Global Economist at Morgan Stanley
MUFG Securities.
Nakazawa-san: And I’m Sho
Nakazawa, Japan Equity Strategist at Morgan Stanley
MUFG Securities.
Lee-san: Today we’re coming to you live
from the Morgan Stanley Japan Summit in Tokyo. And we’ll be
sharing our views on Japan in the context of global economic
growth. We will also focus on Japan’s position vis-à-vis its two
largest trading partners, the U.S. and China.
It’s Tuesday, May 20, at 3pm in Tokyo.
Lee-san: Nakazawa-san, you and I both have
been talking with a large number of clients here at the summit.
Based on your conversations, what issues are most top of mind
right now?
Nakazawa-san: There are many inquiries
about how to position because of the uncertainty of U.S. trade
policy and the investment strategy for governance reform. These
are both catalysts for Japan. And in Japan, there are multiple
governance investment angles, with increasing interest in the
removal of parent-child listings, which is when a parent company
and a subsidiary company are both listed on an
exchange. This reform [would] remove the
subsidiaries. So, clients are very focused on who will be
the next candidate for the removal of a parent-child listing.
And what are you hearing from clients on your side, Lee-san?
Lee-san: I would say the most frequent
questions we received were regarding the Trump administration's
policies, of course. While the reciprocal tariffs have been
somewhat relaxed compared to the initial announcements, they
still remain very high; and there was a strong focus on their
negative impact on the U.S. economy and the global economy,
including Japan. Of course, external demand is critical for
Japanese economy, but when we pointed out the resilience of
domestic demand, many investors seemed to agree with that view.
Nakazawa-san: How do investors’ views
square with your outlook for the global economy over
the rest of the year?
Lee-san: Well, there was broad consensus
that tariffs and policy uncertainty are negatively affecting
trade and investment activities across countries. In particular,
there is concern about the impact on investment. As Former Fed
Chair Ben Bernanke wrote in his papers in [the] 1980s,
uncertainty tends to delay investment decisions. However, I got
the impression that views varied on just how sensitive investment
behavior is to this uncertainty.
Nakazawa-san: How significant are U.S.
tariffs on global economy including Japan both
near-term and longer-term?
Lee-san: The negative effects on the global
economy through trade and investment are certainly important, but
the most critical issue is the impact on the U.S. economy.
Tariffs essentially act as a tax burden on U.S. consumers and
businesses.
For example, in 2018, there was some impact on prices, but the
more significant effect was on business production and
employment. Now, with even higher tariff rates, the impact on
inflation and economic activity is expected to be even
greater. Given the inflationary pressures from tariffs, we
believe the Fed will find it difficult to cut rates in 2025. On
the other hand, once it becomes feasible, likely in 2026, we
anticipate the Fed will need to implement substantial rate
cuts.
Lee-san: So, Nakazawa-san, how has the
Japanese stock market reacted to U.S. tariffs?
Nakazawa-san: Investors positioning have
skewed sharply to domestic-oriented non-manufacturing sectors
since the U.S. government’s announcement of reciprocal tariffs on
April 2nd. Tariff talks with some nations have achieved some
progress at this stage, spurring buybacks of export-oriented
manufacturer shares. However, the screening by our analysts of
the cumulative surplus returns against Japan’s TOPIX index for
around 500 stocks in their coverage universe, divided into stocks
relatively vulnerable to tariff effects and those less impacted,
finds a continued poor performance at the former. We believe it
is important to enhance the portfolio’s robustness by revising
sector skews in accordance with any progress in the trade talks
and adjusting long/short positioning with the sectors in line
with the impact of the tariffs.
Lee-san: I see. You recently revised your
Topix index target, right. Can you quickly walk us through your
call?
Nakazawa-san：Yes, of course. We recently revised
down our base case TOPIX target for end-2025 from 3,000 to 2,600.
This revision was considered by several key factors: So first,
our Japan economics team revised down its Japanese nominal growth
forecast from 3.7% to 3.3%, reflecting implementation of
reciprocal tariffs and lower growth forecasts for the U.S.,
China, and Europe. Second, our FX team lowered its USD/JPY target
from 145 to 135 due to the risk of U.S. hard data taking a marked
turn for the worse. The timing aligns with growing uncertainty on
the business environment, which may lead firms to manage cash
allocation more cautiously. So, this year might be a bit
challenging for Japanese equities that I recommend staying
defensive positioning with defensive non-manufacturing sectors
overall.
Nakazawa-san: And given tariff risks, do
you see a change in the Bank of Japan’s rate path for the rest of
the year?
Lee-san: Yeah well, external demand is
a very important driver of Japanese economy. Even if tariffs on
Japan do not rise significantly, auto tariffs, for
example, remain in place and cannot be ignored. The earnings
deterioration among export-oriented companies, especially in the
auto sector, will take time for the Bank of Japan to assess in
terms of its impact on winter bonuses and next spring's wage
growth. If trade negotiations between the U.S. and countries
including Japan make major progress by summer, a rate hike in the
fall could be a risk scenario. However, our Japan teams’ base
case remains that the policy rate will be unchanged through
2026.
Lee-san: How is the Japanese yen faring
relative to the U.S. dollar, and how does it impact the Japanese
stock market, Nakazawa-san?
Nakazawa-san：I would say USD/JPY is not only
driver for Japanese equities. Of course, USD/JPY still plays a
key role in earnings, as our regression model suggests a 1%
higher USD/JPY lifting TOPIX 0.5% on average. But this
sensitivity has trended down over the past decade. A structural
reason is that as value chain building close to final demand
locations has lifted overseas production ratios, which implies
continuous efforts of Japanese corporate optimizing global supply
chain.
That said, from sector allocation perspective, sectors showing
greater resilience include domestic demand-driven sectors, such
as foods, construction & materials, IT & services/others,
transportation & logistics, and retails.
Nakazawa-san: And finally, the trade
relationship between Japan and China is one of the largest
trading partnerships in the world. Are U.S. tariffs impacting
this partnership in any way?
Lee-san: That's a very difficult question,
I have to say, but I think there are multiple angles to consider.
Geopolitical risk remains to be a key focus, and in terms of the
military alliance, Japan-U.S. relationships have been intact. At
the same time, Japan faces increased pressure to meet U.S.
demands. That said, Japan has been taking steps such as
strengthening semiconductor manufacturing and increasing defense
spending, so I believe there is a multifaceted evaluation which
is necessary.
Lee-san: That said, I think it’s time to
head back to the conference. Nakazawa-san, thanks for taking the
time to talk.
Nakazawa-san: Great speaking with you,
Lee-san.
Lee-san: And thanks for listening. If you
enjoy Thoughts on the Market, please leave us a review wherever
you listen and share the podcast with a friend or colleague
today.
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