Japan: Time for another look? [Quarterly Perspectives] - J.P. Morgan Asset Management

Japan: Time for another look? [Quarterly Perspectives]

Contributor Global Markets Insights Strategy Team

The most obvious attraction of the Japanese stock market is also the most longstanding: it looks cheap. Even though the Nikkei 225 has risen by 180% since March 2009, it remains one of the only developed markets still trading below its 10-year average. It currently has a forward price-to-earnings ratio of around 15, compared with a long-term average of just over 19.

Short-term and long-term support for Japanese equities

Japan has been cheap on most traditional metrics for a long time. Cheap for a reason, many would say. But we see a combination of forces now that might lead to a positive change:

  • Earnings momentum. Japan had the strongest earnings momentum of all the three major developed regions in the fourth quarter of 2014, as shown in the chart. Some 67% of companies in the TOPIX beat earnings expectations, the highest in five years, and earnings per share grew by 8% year on year (excluding energy companies).
  • Technicals. Japan should benefit from strong demand from the official sector in 2015. First, the Government Pension and Investment Fund (GPIF) needs to invest USD 59 billion in the Japanese market to comply with its revised mandate to invest 25% in domestic equities. Second, the Bank of Japan (BoJ) is expected to invest USD 25 billion as part of its expanded programme of asset purchases. If even a small proportion of the USD 4,800 billion invested in the domestic pension fund and insurance industry follows these institutions into equities the impact on the market could be significant.
  • Improving corporate governance. The BoJ and the GPIF will invest through a newly created index, the JPX Nikkei Index 400, composed of companies meeting global investment standards in terms of return on equity (ROE) and corporate governance. The fact that these investments will be published regularly will encourage companies to improve their governance and put more emphasis on shareholder returns by maximising their ROE.
  • Economic and market benefits from cheaper oil. At 3.6% of GDP, Japan’s energy imports are among the highest of the advanced economies, so it should gain more than most from the fall in the oil price. Likewise, energy only accounts for 1% of the MSCI Japan index compared with around 8% of the S&P 500 and 4% of MSCI Europe. The consumer discretionary sector accounts for 23% of MSCI Japan vs. 12% of the S&P 500 and 12% of MSCI Europe.
Investment implications

There have been too many false dawns in Japan for any investor to consider its stock market to be a “sure thing”. Given the depth of the country’s structural problems it is certainly too soon to call Abenomics a success. But the Japanese market has had an excellent start to the year and there are reasons to think the market will remain well supported in the short to medium term. These reasons include attractive valuations, decent earnings momentum and continued structural support for Japanese equities from official purchases. The idiosyncrasies of the Japanese market should also hold some attractions for global investors hungry for diversification; over the last three years, the Japanese equity market has had the lowest correlation with global equities of any of the major developed markets.

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