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Japan’s Equities Head Towards Pre-Tsunami Levels

Four months ago Japan’s huge earthquake and tsunami wreaked havoc with Japanese equities, causing such frenzied selling that the Tokyo Stock Exchange came under pressure to shut the bourse temporarily.

Tokyo stock screens
Grant Faint | Photographer's Choice | Getty Images
Tokyo stock screens

The Nikkei 225 index is now rebounding and homing in on its March 11 close of 10,254.43, when traders had just 14 minutes to react to the quake before trading ended. It finished on Thursday at 10,071.14, above the psychologically important 10,000 level for a second day. On Friday, the index surged over 1 percent at the open, and traded at 10,167.86 by mid day or up 0.95 percent.

Japan’s catch-up over the last month has been impressive. The Nikkei has outperformed many of its Asian peers as well as European indices and the US. In common currency terms, it is up 5.5 per cent, while the FTSE Asia ex-Japan index is 0.9 per cent higher and the S&P 500 trading 4.6 per cent higher.

Analysts say equities’ recent strength is in part due to greater clarity from Japanese companies on earnings forecasts and a ramping up of production as factories come back on line, many at a faster pace than expected after the country’s worst disaster since the second world war.

Fears about the eurozone debt crisis, concern about the pace of the US recovery and the risk of a sharp slowdown in China have, indirectly, benefited Japanese stocks, too.

“The timing of the quake, and the massive disruption and uncertainty has actually produced this neat little skew in timing when Asia is clouding over and visibility in Japan becoming a bit clearer,” says one western banker.

That clarity appears to be encouraging brokers and smaller investors to return to equities, says Peter Eadon-Clarke, a strategist at Macquarie Securites. The market had been relying more heavily on foreign buying, but that turned negative for a few weeks in June.

Indeed, on several measures Japan looks an attractive investment opportunity.

Morgan Stanley MUFG data show the broader Topix index of listed companies is trading at a cyclically adjusted price-earnings ratio of 14.9 times, versus 24 times for the US and between 25 times and 30 times for the rest of Asia.

Moreover, Japan’s 1.65 per cent dividend yield is also higher than benchmark 10-year government bond yields of 1.165 per cent, according to Macquarie.

And Nomura data show the value of share buyback programmes announced in April and May more than doubled to Y505.9bn, compared with the same period in 2010.

Yet, while some individual companies are probably good value, the broader market figures need to be set in context, and there are doubts about the prospect of a sustained rally.

Mr Eadon-Clarke says returns to investors via dividends and share buybacks are not at acceptable levels of around 60 per cent of net profits for a mature economy.

In fiscal 2010 payout ratios fell to 30-35 per cent, from 50 per cent three years earlier, he says.

Foreign investors dominate

After a three-week hiatus, foreign investors were once again net purchasers of Japanese stocks last week, Tokyo Stock Exchange data released on Thursday showed.

They were heavy buyers in the 10 weeks following the March 11 disaster, accumulating Y2,031bn ($25bn) but then started selling, according to TSE and Macquarie data. Last week they came back, purchasing a net Y251.5bn.

There have been signs of more activity from individuals and brokers but foreign investors dominate, accounting for between 60-70 per cent of trades.

Macquarie and Nomura point out that companies are much more cautious about sharing profits following the March 11 disaster. Mr Eadon-Clarke’s estimates suggest that payouts will be around 45 per cent in fiscal 2012.

And, while there is more clarity among manufacturers on production and rebuilding efforts that are expected to start in earnest later this year, there remain huge uncertainties around the finances of Tokyo Electric Power, the company at the centre of the Fukushima nuclear crisis.

That, as well as the implications for nuclear policy and continued political turmoil, has weighed on sentiment.

The bill to save Tepco may have passed the cabinet, but it is still vague on important issues and is likely to face intense debate in parliament.

“[The financial arrangements surrounding Tepco] are a serious problem for the market,” says Alex Kinmont, chief Japan equity strategist at Morgan Stanley MUFG. “Until that is cleared up it will be tough for the market to rally.”

The Japanese equity market is also influenced by the outlook for the global economy. So, worries about the recovery are reflected in stocks with international exposure including carmakers, technology companies and capital goods manufacturers.

Mr Kinmont argues that there should be an earnings recovery in the first calendar quarter of next year, but that investors will be reluctant to discount that too early into stock prices.

“The real threat [overseas] is fiscal tightening in the US. If all the tax cuts expire according to timetable then fiscal policy in America will tighten to the tune of about 1 per cent of GDP,” he says.

In 1995, the year of the Kobe earthquake, the Nikkei was trading at an average of more than 17,000. It is now down to about quarter of its peak level of 1989.

The rally may well have further to run, with Japanese equities recovering fully to pre-quake levels. But it will take a good deal more to drive stocks higher, including an end to Japan’s prolonged deflation, to power a really convincing recovery in share prices.

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