Earnings Optimism to Take Japan Markets Higher

Japan’s stock market, one of the biggest laggards in Asia last year, logged its best first-quarter performance in over two decades, and investment strategists say optimism over corporate earnings will drive the country’s stocks even higher as supply chain constraints caused by the Thai floods ease.

Tokyo stock screens
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Tokyo stock screens

“Japanese companies are going to perform well in the upcoming fiscal year, with earnings set to rebound around 30 percent,” John Vail, Chief Global Strategist at Nikko Asset Management, told CNBC. First quarter earnings for Japanese companies are due mid April.

Geoff Lewis, Head of Investment Services at J.P. Morgan Asset Management forecasts earnings growth among Japanese corporates will be the highest among G-7 countries over the next 12 months.

Rattled by a strengthening yen, an ongoing nuclear crisis and the Thai floods, the benchmark Nikkei 225 and Topix, both declined close to 20 percent last year. However, both indexes have already recovered nearly all those losses in the first three months of the year, up 19.3 percent and 17.3 percent respectively.

Benjamin Collett, Head of Japanese Equities, Louis Capital Market sees the Nikkei average moving 30-40 percent higher this year from current levels.

Yen to Weaken Further

Further commitment from the Bank of Japan (BOJ) for additional monetary accommodation and continued proof that the yen has peaked, two factors that have supported investor confidence in the Japanese market over the last three months, are also pivotal to the performance of the country’s stocks, according to the strategists.

Collett adds, “as long as the yen continues to weaken these profits are going to go up in a parabolic arch.”

The BOJ last expanded its asset purchase programin February by 10 trillion yen, to 65 trillion yen, as part of efforts to weaken the yen and beat deflation and Collett expects the central bank to continue on this path.

“I think the gloves are off. They (the BOJ) will throw everything that they need to into this given all the expectations that are built into the market,” he said.

Nikko’s Vail believes that the central bank’s recent actions thus far have been “aggressive enough”, and sees the dollar-yen rising to 88 in September, helping to boost the competitiveness of the exporters.

Collett, who agrees the yen is set to devalue further, says a weaker currency will enable exporters to maintain their vulnerable market share and place them in an “advantageous” position.

“They have managed with a strengthening yen for so long while keeping their quality of production very high. Now the major obstacle [strong yen] has shifted,” he said.

Not Too Late to Get in

Despite recent gains for Japanese equities, strategists still think there is further upside and it’s not too late to get into the market now.

J.P. Morgan’s Lewis upgraded his outlook for Japanese equities to overweight from neutral in March.

“I have upgraded Japan to reflect the strong cyclical recovery in earnings that is likely over the next 12 months, combined with very cheap equity valuations,” Lewis said. The Topix index is trading near one times price-to-book, according to J.P. Morgan Asset Management.

While Lewis believes the 12-18 month outlook looks upbeat, he cautions that Japan’s long-term structural outlook remains bleak.

When comparing valuations of the Topix to its U.S. peer S&P 500 , Vail says their price-to-earnings ratios for the current calendar year are on par at approximately 13.5 times.

“It’s not as cheap as it was two months ago, but I still think it’s attractive at these current levels,” he said.

Nikko Asset Management forecasts the Topix will hit 933 by September, which marks a 9 percent upside from current levels.