Unigestion's Mollin-Elliott: What will drive the Japanese equity market over the next 12 months?
Fiscal stimulus and central bank intervention possibilities
Japanese equity market drivers for the next 12 months include fiscal stimulus, Bank of Japan (BoJ) intervention, the impact of Covid-19 and EPS revisions.
Fiscal stimulus should be supportive of a sharp economic rebound: Japanese government announced its second supplementary budget on 27 May with fiscal spending of ¥31.9trn (5.9% of GDP).
The main focus of this budget is to support companies and avert bankruptcies and lay-offs. Japan's economy should now be well supported and be in a strong position to rebound from the Covid-19 impact.
Recent data is pointing to a rosier economic outlook as on 8 June, Japan Real GDP for Jan-Mar was -2.2% QoQ (annualised) vs. -3.4% reported preliminarily.
BoJ intervention provides a floor to the Topix with a heavier weighting towards larger cap stocks: BoJ has increased its ETF purchases and set its upper limit at ¥12trn per year at MPM on 16 March.
It went from buying ¥421bn in January, ¥562bn in February to ¥1.5trn in March and ¥1.2trn in April. This has supported the market and during the most active months was >2% of volumes.
In May, the BoJ slowed down purchases to ¥421bn as the market rallied during the month and there was no need to 'support' the market.
Covid-19 will have an impact on short-term, pent-up demand and longer-term structural drivers: In the near term, normalisation will benefit IT services, shipping, and inner-city railways.
In the long-term, the pandemic may lead to structural shifts in Japanese society, particularly in the upgrading of technology. Industries that might benefit include technology related industries, logistic facilities, pharmaceutical and healthcare and some insurance companies.
These sectors have generally outperformed YTD and may face a tactical reversal, however, changes such as the reliance on technology for remote working, increasing share of e-commerce and focus on wellbeing will persist after the virus disappears.
On the other hand, there are some long-term structural losers, such as hotels, department stores, cosmetics, airlines and some auto OEMs. These sectors may see a short rally from a positioning rotation but are likely to underperform over the longer term.
EPS estimates still have room to be cut: Guidance for FY3/21 given by the small percentage of companies that had sufficient visibility to provide it, was for sales and operating profit falling by 6% and 11%, respectively. There is a risk that these estimates may still be too high.
Stefanie Mollin-Elliott is a fundamental analyst at Unigestion
Bull points
• Japanese equities are cheap compared to global equities and their own history provide upside potential. The Topix is trading on 13.8x (2021E) vs. 17.3x for the MSCI ACWI. The ACWI typically trades at a 13% premium to the Topix but that premium has expanded to 27%. This implies valuation support for the Topix.
• If Covid-19 cases in Japan remain under control and further restrictions are lifted, such as big events and tourism, then April-June could be the bottom for the economy and there will be a recovery in GDP from July-September, assuming there isn't a second wave of the virus.
Bear points
• Second wave of Covid-19 could prolong Japan's recession with all the knock-on impacts.
• Monetary stimulus, in the form of interest rates/yield-curve-control, is not in the BoJ's toolbox as near-term yields rates are already negative.
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