Why Japanese equities will be on the up from next year
Japanese equities have been sensitive to weaker global industrial demand over the past 12 months, but we expect the earnings impact from the ongoing slowdown to bottom out by the end of this fiscal year.
Into the new year, consensus expectations forecast aggregate earnings growth of 6%, supported by a broad-based recovery in industrial demand.
Having underperformed other developed markets, valuations remain attractive as the TOPIX trades at a P/E lower than its historical average and significantly lower than that of both US and Europe.
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Japanese equities have suffered collateral damage through the ongoing stand-off between the US and China.
However, recent developments in negotiations on tariffs have been more promising.
The near-term outlook for Japanese companies has also been hampered by a 2% hike in national consumption tax, which came into effect on the 1 October.
While the new rate applies to nearly all goods and services, we expect the knock-on effects on consumption to be more limited relative to the last hike in 2014.
The hike is lower in absolute terms and the government has stepped in to provide various measures to offset the impact, including exemptions on food and certain necessities.
There has also been widespread speculation about additional easing from the Bank of Japan (BoJ) in the event of a severe impact on inflation from the tax hike.
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The BoJ has room to provide more easing measures, which tend to provide a tailwind for Japanese equities.
Of course, a sudden decline in US growth impacting other regions could pose a serious threat to corporate earnings, but central banks and governments in the respective countries are still well placed to respond to such events.
Notwithstanding recent constructive development on the US-China trade war, next year's US presidential election presents some risk of stagnation in further progress.
Indeed, China might wait for the election of the next US president before taking further steps towards a resolution.
Against this backdrop, a widespread and long-lasting risk-off sentiment could trigger yen appreciation, which could have a negative impact on Japanese companies.
Ichiro Kosuge is lead portfolio manager and head of the Japan fundamental equity team at Goldman Sachs Asset Management
Bull Points
• Valuations could remain attractive amid slowdown in industrial demand
• Consumption could prove resilient even after the recent tax hike
Bear Points
• Extended slowdown in global demand could happen
• Risk-off sentiment could lead to yen appreciation
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