Driven down by the weakening renminbi, the declining crude oil price, and worries over European banking sector debt; the value of the Japanese stock market is at its lowest level since prime minister Shinzo Abe came to power in 2012.
Bank of Japan
The BoJ voted against releasing further stimulus during its policy meeting on Thursday, a move that caught the global markets off guard. The fallout of the inaction was a further strengthening of the yen and a sharp drop in the Nikkei.
While many were disappointed by the decision, citing it as further proof that ‘Abenomics’ has failed, SNAM expects the government to release a hefty supplementary budget of around 1% of GDP, or $500bn (£343bn, €441bn), before the country’s Upper House elections in July.
Additionally, economists think that there is a 60-70% chance that the government will postpone a scheduled consumption tax increase from 8% to 10% that was due to be introduced in April 2017.
"We think that the Japanese equity market is deeply undervalued.”
That said, however, the BoJ’s inaction has given its economy an even bigger inflationary hill to climb.
China
“The Japanese stock market is very sensitive to global economic sentiment,” says Shohei Masuyama, senior product specialist at SNAM. “By market cap, about 30% of the Japanese stock market is owned by overseas investors. So when the global market goes down, they tend to liquidate their Japanese equity position.”
The Chinese stock market crash in the summer of 2015, which saw its value drop by around 30%, and the 18% crash in early January 2016 were keenly felt in Japan with significant outflows recorded during both periods.
“Japanese yen is favoured as a safe haven currency”, with global economic concern resulting in a shift toward yen, further driving down the Japanese stock market, explains Masuyama.
But while China has caused Japan some additional pain of late, the increasing stabilisation of the renminbi could act as something of a balm.
Bright spots
SNAM uses two indices to measure market sentiment: the price of crude oil and the renminbi.
After bottoming out at less than £30 per barrel during the first quarter of the year, SNAM sees the recovery in the price of crude oil is a reflection of market sentiment.
Over the past year, the renminbi has moved in line with the price of oil, which SNAM believes indicates increasing stabilisation in the currency.
“And that is good for the Japanese stock market, and the economy, as there will be less demand on the yen and it will depreciate,” Masuyama says.
Stronger corporate earnings
SNAM expects year-on-year EPS growth of between 5.5% and 8% in financial year 2016, driven by four primary factors.
- Global growth of 3%, year-on-year, is expected to continue;
- Lower commodity prices will reduce corporate expenditure and improve earnings;
- Corporate tax is to be lowered from 32% to 30% this fiscal year;
- Share buy-backs are increasing rapidly. After hitting a historic high in 2015, they are expected to be 10% higher in 2016, driven by increased corporate governance and the negative interest rates introduced by the BoJ.
Equity market forecast
“After the Abe government came into power, the average P/E ratio ranged from 14x to 15x, which we think is the norm,” says Masuyama. “However, P/E ratios currently range around 12x to 13x, which we think is overshooting.”
The company expects that there will be a gradual recovery to the norm.
With the Tokyo Stock Price Index (Topix) closing 2015 at 1547, SNAM expects a 10% increase by the end of 2016 to close out this year at 1650.
However, after a sharp decline in the first quarter, Topix currently sits around 1,400.
Despite this, SNAM expects a more than 50% recovery on the back of strong corporate earnings, the stabilisation of the renminbi, and the supplementary budget expected in July.
The company’s Topix forecast is based on EPS of JPY110 ($1.01) and a P/E ratio of 15x.
“Even using a more conservative valuation of 14x, you still get over 1500,” says Masuyama. “So, in other words, we think that the Japanese equity market is deeply undervalued.”
