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Where are Japanese equities heading?

Where are Japanese equities heading?

Aside from improving fundamentals, Japanese equities have Donald Trump to thank for the considerable inflows since November. 

A weaker yen has bolstered the case for Japanese corporates, driving the Topix up to 1,554.6 from 1,301.1 on November 9.

However, equity specialists are warning of increased political risk and policy changes in the following months, which could potentially hurt the market.

Citywire Asia presents the views of experts from fund houses and private banks on where Japan is heading.

Shunsuke Matsushima, Sumitomo Mitsui Asset Management Company

Head, equity investment group

In late 2016, as the U.S. long-term interest rates rose and USD appreciated against JPY, market expectations heightened for Japanese corporate earnings recovery, encouraging foreign investors to re-enter Japanese equities.

The Japanese equity market has been rising so far, and the investments from the foreign investors seem to be still in place.
 
Going forward, USD is likely to strengthen against JPY with the U.S. tax cuts and fiscal expansion under Trump administration in the background.

Also supported by the recovery trend for the global economy, we expect the Japanese corporate earnings to recover for 2017.

Accordingly, based on our outlook for bullish stock market, capital inflow from foreign investors into Japanese equities is anticipated to continue.

Meanwhile, 2017 is a year of important elections for major European countries, whose results could trigger risk-off mode in the market, leading to JPY appreciation and stock market decline.

While the foreign investors’ capital could continue flowing into the Japanese equities, we are aware of possibility of the foreign capital outflow if the political risks become apparent.
 
We forecast the P/E ratio to be undervalued based on the FY2017 earnings. Meanwhile, P/B level for Japanese stocks is significantly undervalued, and Japan is one of the most undervalued among developed countries’ stocks.
 
We consider that machinery such as robotics, or related electronic components and software would grow significantly, with the megatrends such as pursuit of production efficiency in the background.

Suresh Tantia, Credit Suisse Private Banking

Investment strategist

The Japanese equities could underperform global markets as its outperformance since the US Presidential election has been mainly driven by currency weakness but we expect JPY to strengthen going forward which will weight on exporters.

Furthermore, valuation appears to be stretched compared to economic momentum with 2017E P/E ratio of 18.3.

Though there has been an ongoing recovery in economic fundamentals, uncertainty pertaining to politics and policy measures remains high.

The Bank of Japan (BoJ) is expected to keep both its policy rate and the 10Y yield target unchanged. However, in a scenario of a disappointment, the market could adopt a more risk-off sentiment and fall sharply. 

Dean Cashman, Eastspring

Team leader and Japan equity portfolio manager

Whilst the improved market performance is being reflected in broad market valuations, at corporate level, we continue to observe encouraging trends.

The ongoing opportunity in Japan is the unlocking of value for shareholders. Increased domestic ownership of equities has sparked a rising focus on governance from domestic investors in order to increase shareholder returns. Investor engagement with companies is causing the latter to focus on improving capital efficiency, increasing dividends as well as share buybacks to improve total returns.

There are many companies in strong financial health and observe that companies’ restructuring efforts are continuing and in some cases have accelerated. 

Equity returns can be unlocked by a company’s ability and willingness to increase their payout to shareholders.

Progress on total shareholder return continues to gain traction; however there is ample scope for this to rise to higher levels in Japan. With over half of Topix non-financial stocks trading on net cash, arguably for many companies, balance sheet health is “too strong” and points to a level of inefficiency.

However companies are now in a position to focus on improved capital efficiency; generate significant cash flow; and pursue sensible expansion strategies.

Our approach is not reliant on forecasting or forecast accuracy. We accept that it is extremely hard to be more 'informed' than the market.

Our approach is to anchor our decisions around what the market is already 'pricing' for an asset and ensure that we are being amply compensated for observed risks with significant valuation upside.

Standard Chartered Wealth Management Advisory team

Led by Alexis Calla, global head, investment strategy & advisory

Positive equity market returns remain highly dependent on a view of further yen weakness, a view that we believe is at risk from two fronts. First, a bout of safe-haven demand (for the yen) and, second, a rise in inflation-adjusted yields as inflation fails to firmly take hold.

That said, in the short term, Japan’s equity market looks set to break higher on the back of a sharp upgrade to earnings forecasts.

We have downgraded Japan to core from preferred, reflecting our reduced conviction over the growth outlook and diminishing upward revisions to earnings. However, we are retaining our thematic positive view on Japan’s equities on a currency-hedged basis as we believe the short term (1-3 month) outlook is constructive.

Japan’s corporates have been able to significantly increase profits in recent years, aided by JPY weakness. Looking ahead, we are less bullish on USD/JPY, reducing our conviction over the 12-month outlook for corporate profits. Another factor that could weigh on the 12-month outlook is US trade policies with companies listed in the auto and capital goods sectors particularly at risk.

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