Macro scenarios and the Japanese stock market

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Macro scenarios and the Japanese stock market
Japan trades at 13 times earnings, 1.3 times book value and 2.4 per cent dividend yield, a discount to the US, Europe and most major Asian stock markets (ex-South Korea).

Published: Sun 18 Feb 2018, 3:00 PM

Last updated: Sun 18 Feb 2018, 5:22 PM

It is ironic that the Japanese economy has recorded its strongest growth rates since 1989 at the precise moment that the Nikkei Dow index plunged 12 per cent below its recent peak. While the Cabinet Office's confirmation of 0.5 per cent growth in the last three months of 2017 seems dismal by Indian, Chinese or even German standards, the fact remains that Japan is no longer mired in deflation, a testament to the success of Abenomics, the policy of synchronised fiscal stimulus, monetary easing and structural reform named for the current LDP Prime Minister. Private consumption, capex and exports now all contribute to the economic recovery momentum of Japan Inc in 2018. GDP growth, however, slowed after September and the Bank of Japan will not prematurely scale back the most aggressive central bank monetary easing programme on the planet relative to GDP anytime soon. The GDP data also make it certain that Prime Minister Abe will reappoint Kuroda-san as the governor of the Bank of Japan when his term expires in April.
This has profound implications for the yen and the outlook of the Japanese stock market. It did not surprise me to see the yen spike up to 107 against the US dollar last week breaching a critical chart point at 107.80. The Japanese fiscal year ends in March and creates seasonal upward pressure on the yen. Many hedge funds and real money accounts were forced to liquidate trapped long dollar/yen positions once the Chicago Volatility Index (VIX) surged on inflation angst on Wall Street. Japan, after all, is a global safe haven currency for Planet Forex, just like Switzerland. Yet the macroeconomic realities are stacked firmly against the yen.
One, the ten-year US Treasury note yields 2.85 per cent while the ten-year Japanese Government Bond is a mere 7 basis points.
Two, US economic growth will accelerate in 2018 due to Trump's tax reform.
Three, the Powell Fed will raise the Fed Funds rate at least four times in its anti-inflation vigilance while the Kuroda Bank of Japan continues to "nationalise" the government bond market, 98 per cent owned by domestic investors.
Four, the Volatility Index has fallen to 19 from panic peaks near 48 as global equity markets stabilise. This is all negative for the Japanese yen in the months ahead and I reiterate my year end targets at 115.
While it is true that the Prime Minister Abe wants Japan Inc to raise wages in the spring wage negotiations to boost private consumptions, I do not believe this alone will trigger a monetary "taper" from the Bank of Japan. Both Abe and Kuroda know full well that this could lead to a yen spiral above 100 and essentially kill Abenomics. The Bank of Japan's entire monetary strategy since 2012 would be negated by a premature taper.
Japan is a "growth warrant" on the global economy even in the Digital Age. So if my yen call is correct, Marunouchi is a buy with the Topix at 1,700 and the Nikkei Dow index at 21000. Earnings growth in listed companies is strong and accelerating. A rise in free cash flow portends a boost in dividends and shares buy backs. Japan Inc has 117 trillion yen in cash on corporate balance sheet and the government pension fund, let alone gaijin investors, can well increase allocations to Japanese equities in 2018.
Japan trades at 13 times earnings, 1.3 times book value and 2.4 per cent dividend yield, a discount to the US, Europe and most major Asian stock markets (ex-South Korea). Governor Kuroda's reappointment in April will signal a new commitment to the Bank of Japan's zero yield policy, which necessitates yen depreciation. This will ignite the "animal spirits" of both Japan Inc and global investors who are nowhere near maximum overweight Japanese equities. In any case, the easing of geopolitical tensions in North Korea should be reflected in lower risk premia in Japanese equities but the opposite has happened in February 2018.
My key investment themes in Japan are anchored in both macro and stock specific factors. The world's oldest society, with untold trillions in savings, cannot ignore the 4.2 per cent yield on the Tokyo Stock Exchange Reit index. Sony remains the most compelling restructuring story in the Empire of the Rising Sun, ideally at 4,600 yen for new money. Nomura is a deep value investment bank and broker at 0.8 times tangible book value. Hitachi and Fujitsu remain my favourite megacap exporters in the Empire of the (hopefully) Rising Nikkei.
 
 
 

By Matein Khalid
 Macro Ideas

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