The 49 percent rally that pushed Japanese stocks past every other developed market in 2013 has done nothing to increase valuations, a sign to the world’s biggest investors that the advance will last.
Topix index shares trade at 15.6 times estimated profits, 30 percent below the average of 22.2 since 2001, according to data compiled by Bloomberg. Earnings per share for companies on the gauge are forecast to jump 12 percent in the next 12 months, the data show. Strategists expect the equity measure to rise 16 percent to 1,484.50 by the end of next year.
The Topix’s surge in 2013 represented the biggest gain relative to U.S. equities since 2005 -- even though the Standard & Poor’s 500 Index increased 29 percent. The rally will extend into next year as the policies of Prime Minister Shinzo Abe boost growth and the yen weakens, fund managers from JPMorgan Chase & Co. to Mizuho Asset Management Co. say.
“We still expect Japan to outperform the global equity markets,” said Grace Tam, a Hong Kong-based global market strategist at JPMorgan Asset Management, which oversees $1.5 trillion. “U.S. tapering is good for Japan as the dollar will get stronger and the yen weaker. Investors are also starting to price in additional easing from the Bank of Japan.”
Sustaining gains has proven difficult in Japan. The Topix fell four of the previous six years and traded as of yesterday 56 percent below its record high in 1989 and 30 percent short of its pre-financial crisis peak in 2007. This year’s advance is the fourth-biggest on record. The two largest were a 101 percent surge in 1972 and a 58 percent rally in 1999. Both times the gauge tumbled the next year -- 24 percent amid the oil crisis of 1973 and 25 percent as a bubble in technology stocks burst in 2000.
“Gains won’t be short-lived this time,” said Kuninobu Takeuchi, a Tokyo-based portfolio manager at DIAM Co., which oversees more than $124 billion. “There’s a new regime in town and it’s taking steps to finally end 15 years of deflation.”
Valuations in the Topix fell in 2013 even as the index posted its best rally since 1999, as the 49 percent advance failed to keep up with a 59 percent increase in income, according to analyst estimates compiled by Bloomberg.
The price-earnings ratio for companies on the Topix dropped about 6.5 percent to 15.6 times estimated profits from 16.7 at the end of 2012, as analysts boosted their predictions for income in the next year from 51.59 yen per share at the end of 2012 to 82.12 yen on Dec. 25. The ratio for the S&P 500 increased 23 percent in 2013 to 16.6, while it jumped 21 percent to 15.3 for the Stoxx Europe 600 Index.
The Japanese gauge trades at 1.3 times book value yesterday, compared to 2.7 for the S&P 500 and 1.8 for the Stoxx 600.
“Valuations are still reasonable,” said Masaru Hamasaki, a senior strategist at Tokyo-based Sumitomo Mitsui Asset Management Co., which oversees about 11 trillion yen ($105 billion). “A stable strengthening of the stock market is likely to continue into next year.”
Profit at companies on the gauge more than doubled to 74.70 yen per share this year, according to data compiled by Bloomberg. Earnings per share are forecast to increase 12 percent over the next 12 months, analyst estimates compiled by Bloomberg show.
Escalator vs. Elevator
“We expect the market’s upward path in 2014 to be more gradual than in 2013, i.e. more like an escalator than an elevator,” Goldman Sachs Group Inc. strategists led by Kathy Matsui wrote in a report dated Dec. 19.
Toyota Motor Corp., which gets about 75 percent of revenue outside Japan, said in May a one-yen weakening against the dollar boosts operating income by 40 billion yen. The world’s largest carmaker raised its profit forecast 13 percent to 1.67 trillion yen on Nov. 6, based on an assumption of the yen at 97 per dollar. The currency traded at 104.96 per dollar today. Panasonic Corp., the biggest supplier of batteries for electric cars, doubled its outlook in October, also citing the yen.
The Japanese currency, which strengthened to a post-World War II record of 75.82 per dollar in October 2011, plunged 22 percent this year through yesterday as Bank of Japan Governor Haruhiko Kuroda pledged to double the monetary base by buying more than 7 trillion yen of bonds a month in a bid to stoke 2 percent inflation. Analysts expect the yen to drop to 109 in the fourth quarter of 2014, estimates compiled by Bloomberg show.
The economy will probably contract an annualized 3.9 percent in the three months after Japan raises its consumption tax to 8 percent in April from 5 percent now, according to the median forecast of 31 economists surveyed by Bloomberg.
The BOJ won’t hesitate to adjust policy if needed to achieve its price target, Kuroda said Dec. 20. All but one of 35 economists surveyed by Bloomberg Dec. 10-12 expect further easing by the central bank. Thirty-seven percent predict an expansion of monetary stimulus in the quarter after the levy is increased.
“If economic fundamentals deteriorate because of the sales tax, the government will have to act,” said Seiichiro Iwamoto, who helps oversee the equivalent of $33 billion at Mizuho Asset Management Co. “Japanese stocks will continue to rise next year. With the policies we’ve seen so far, there’s no way the advance will end next year.”
All 10 strategists surveyed by Bloomberg this month expect the Topix to rise by the end of 2014, with the median forecast for a 16 percent advance to 1,484.50. JPMorgan Chase & Co. is the most bullish, predicting a 37 percent jump to 1,750.
Out of Ammo
Not everyone is as optimistic. Tomomi Yamashita, a fund manager at Shinkin Asset Management Co. in Tokyo, which oversees the equivalent of $5 billion, says that the BOJ’s easing program is running out of ammunition.
“I don’t expect that much for Japanese shares next year,” Yamashita said. “If doubling the monetary base doesn’t work, there isn’t much else left they can do. Buy some real-estate investment trusts or exchange-traded-funds maybe? I don’t expect they’ll do much more.”
Also raising concern is Abe’s visit to a shrine that honors war criminals and others yesterday, risking deepening tensions with Japan’s largest trading partner. Trade between Japan and China has almost tripled since 2000 to about $250 billion, increasing the commercial cost of political fallout between Asia’s two largest economies.
The Fed said on Dec. 18 it will trim its monthly bond purchases to $75 billion from $85 billion from January, amid signs of a recovery in the labor market. The yen fell to a five-year low against the dollar after the announcement.
“Normalization of the global economy, such as an end to the Fed’s quantitative easing, could prompt outperformance by Japanese stocks,” Naoki Kamiyama, equity strategist at Bank of America Corp.’s Merrill Lynch unit, wrote in a report Dec. 2. A trend “that substantially improves Japanese companies’ profitability seems to have started.”
The rally this year has coincided with inflows from foreign investors, which make up about 60 percent of the share market. Overseas investors bought Japanese shares every month except August this year through November, data from the Tokyo Stock Exchange show. Individual investors and local financial institutions have sold in all but one of the months, the data show.
“While there is potential for additional foreign inflows, the focus in 2014 is likely to shift to domestic investors,” Matsui wrote in a report dated Dec. 19. “We anticipate investment activity from retail, investment trusts, corporates and potentially the Government Pension Investment Fund.”
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