Is the bullish case for Japanese stocks still intact? I am talking about the “fundamental” case, not simply continued momentum from the market’s three month surge that must surely weaken and—if unsupported by fundamentals—falter in the weeks and months ahead.
Today, March 12, the Nikkei index registered its first decline in nine days, falling 34 points to 12,314 yen. Last Friday’s close of 12,283 yen came after a 315 yen (2.64%) surge, the second biggest of the year. Apart from the strength of the rally, the Friday close was important as it pushed the index past the 12,214 level reached on September 12, 2008, i.e., just before the “Lehman shock” set off the global financial crisis and sent Japanese stocks plunging.
It is interesting to compare economic indicators from 2008 and the present. Japan’s nominal GDP in FY 2008 was 489 trillion yen. Annualizing the October-December 2012 quarter puts it today at 471 trillion yen. Japan’s index of industrial output (2005=100), 103.5 in August of 2008 had fallen to 89.7 in January this year. The CPI (2010=100) was 103.1 in August 2008 vs. 99.3 in January 2013. On September 12, 2008 the yen/dollar and yen/Euro exchange rates were 107 yen and 151 yen respectively. At March 8, 2013 they were 95 yen and 125 yen. More dramatically still, on the same respective dates the yield on long term JGBs were 1.53% and 0.65%.
With the Dow at historic highs and other global markets, notably Germany’s, having advanced much further relative to their September 2008 levels, the recovery of the Nikkei 225 looks less impressive. Indeed, the “blue chip” companies that populate the Nikkei 225 have as a whole been fairly unspectacular in their recoveries, while some (Sharp and Sony come easily to mind) have been disastrous failures.
The relative underperformance has not been confined to big companies, however. The TOPIX index comprising all of some 1,700 companies on the Tokyo Stock Exchange’s first section closed on March 11 at 1039.98 points. It has risen dramatically from a low of 722 on November 13 of last year. But the peak of the TOPIX in 2007 was 1816 and just before the Lehman shock 1430. Clearly, then, the broader market has not done a greatly better job than the blue chips in recovering previous peaks.
But Japan’s relative market underperformance should not be surprising. The global financial crisis brought into sharp relief weaknesses and competitive disadvantages present in Japan’s micro- and macro-economic model. These include weak domestic demand (and corporate profitability) in many sectors, such that growth has often been in overseas investments and exports; high relative costs and lost international competitiveness compounded by a strong yen (translating also into reduced earnings from converted foreign profits); in many cases still cautious and piecemeal restructuring and cost cutting efforts due, inter alia, to paternalistic, restrictive labor regulations; and, finally, high Japanese corporate taxes.
The question is the degree to which these weaknesses and disadvantages continue to weigh on Japan’s corporations’ ability to grow and make profits that will be reflected in higher stock prices going forward.
Since the victory of Abe Shinzo and his “Abenomics” agenda became a foregone conclusion last November, the biggest economic change—and market mover–has been the dramatic weakening of the yen. With Abe’s nomination of looser money advocate ADB president Kuroda Haruhiko as the new BOJ governor, and with signs of a global pickup in demand, especially in the U.S. and China, the yen last week descended through the 96 yen/dollar level and is, we may expect, headed for 100 yen/dollar or lower.
Since November 14 these developments have powered rises in the stocks of Fuji Heavy Industries (PINK:FUJHY) by 200%, of Bridgestone Tire (PINK:BRDCY) by 85%, and Honda Motors (NYSE:HMC) by 60%. Japanese financial stocks, as especially the megabanks, have been in a positive feedback loop of balance sheet and income statement translation gains from a weaker yen and the prospect of increased loan volumes and interest earnings from higher domestic loan demand. The stocks of Mitsubishi UFJ Financial Group (NYSE:MTU) are up 65% and those of Sumitomo Mitsui Financial Group (NYSE:SMFG) up 75%. A related trend is the rise in real estate heavy stocks, with such names as Tokyo Municipal Horse Racing up 290%, Tokyo Dome up 62% and JR Eastern Japan up 50%. REITs listed on Japan’s exchanges have been hot. On March 11 the Japan REIT index reached a four year eight month high, 10% above the level immediately preceding the Lehman shock.
With regard to the more structural cost and competitiveness weaknesses of Japan’s corporations, these are also being addressed by Japan’s best companies, with iconic giants like Hitachi Ltd. (PINK: HTHIY)—domestic stock price up 36.6% since November 14– and Panasonic (NYSE:PC)—up 80.7%–setting an example with massive restructurings and globalization initiatives.
With such rises behind us, we must be cautious, turning the fundamentals analysis to valuation. At today’s closing level for the Nikkei 225 average stocks, the price-to-book ratio has risen to 1.33 times; the price-earnings ratio to 27.06 times trailing and 21.20 times forecast; the EPS yield to 3.91% trailing and 4.60% forecast; and the dividend yield 1.53% trailing and 1.56% forecast. To me this suggest that the market has already priced in a lot of good news and risen to a level from which there will be limited upside potential (and substantial downside risk) for several quarters.
I will close by noting, contrary to my own more cautious view, the bullish stance of many Japanese analysts based on a view of the still relative underweighting of the Japanese market by global funds managers, and the potential for gains from reallocation into Japanese stocks. Such an analysis was provided by Mizuho Securities’ Pan-Asia Chief Equity Strategist Kikuchi Masatoshi in an interview with Nihon Keizai Shimbun on March 9. Kikuchi notes that already this year foreign buyers have been JPY 2 trillion net buyers of Japanese equities. He forecasts that for the year the net demand could be JPY 6 trillion.