Japanese stocks appear to be vulnerable to a multitude of risks.
Just when the trade wars seem to be abating, the emergence of a deadly new coronavirus triggered a sell-off in Asian equities.
Foreign investors sold ¥332bn of Japanese stocks in January, the second straight month of selling, on concerns the virus will stymie the expected recovery in Asian economies this year.
The 'structural evolution' taking place in Japanese equities
The main impact of the virus is the potential disruption to global supply chains if key components cannot be produced in China.
Japanese automakers such as Toyota and Nissan delayed restarting their China factories following the Lunar New Year break due to the virus.
Inbound tourism to Japan will also be affected as people cancel their travel plans.
Japan's Q1 GDP will undoubtedly take a hit, but the impact to annual GDP growth is mitigated by the fact that inbound tourism only makes up 0.8% of Japan's GDP, while manufacturing can make up for the shortfall in production in subsequent quarters once things normalise.
Indeed, Japan's GDP is more dependent on domestic consumption and capital expenditure.
In this regard, while retail sales fell 6.5% quarter-on-quarter in Q4, this was mainly due to the frontloading of consumption in the previous quarter before the October sales tax hike.
The good news is that the jobs market remains tight with unemployment rates at just 2.2%. As such, wage growth will probably continue to grow moderately and support spending.
Another positive is corporate earnings have turned the corner after a terrible 2019, where earnings were slashed by over 11%.
Consensus estimates for 2020 earnings growth for MSCI Japan is reasonable at under 6% - the lowest among developed markets.
There is every chance companies can deliver stronger earnings if the coronavirus proves to be a short-lived one, and the global economy rebounds in Q2.
The Asian sector due to see the biggest growth rebound
Meanwhile, reforms in Japan's corporate governance regime continue to gain momentum. Share buybacks and dividends reached a record high of ¥16tn in FY19 and this trend is poised to continue.
Japanese corporate ROEs have improved significantly over the past few years due to the growing awareness of boosting shareholder value.
We believe 2020 could be the year Japanese equities lose the stigma of being a "value-trap".
Daryl Liew is CIO of REYL Singapore
Bull Points
• Earnings revisions turning positive
• Strong jobs market
Bear Points
• Uncertainties of the impact of the coronavirus
• Shrinking and ageing population
