Sell Signals Hitting U.S. Shares Flash Buy for Japan Bulls

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From profits to policy, the things that are working against U.S. stocks are bolstering Japanese equities.

So say bullish investors from BlackRock Inc. to Baring Asset Management Ltd., even with the Topix index near an eight-year high, as earnings growth strengthens an argument to buy that also includes low valuations and a central bank intent on loose money. Corporate profits are forecast to increase faster in Japan than in the U.S. over the next two years.

Investors in American stocks face the likelihood the Federal Reserve will tighten policy next month. The Standard & Poor’s 500 Index commands a valuation premium to the Topix even though it has one of the lowest returns this year among developed equity markets. BlackRock and Baring Asset say buying Japan and selling U.S. shares is the only logical conclusion.

“The delivery of earnings has been spectacular relative to Europe, the U.S. and everywhere else,” said Khiem Do, Hong Kong-based head of multi-asset strategy at Baring Asset, which oversees $41 billion. “We’ve been selling down the U.S. over the last six months and putting more money into Japan.”

The Topix rose 19 percent this year through Monday, against a 1.6 percent gain by the S&P 500. The Japanese benchmark gauge advanced 14 percent in U.S. dollar terms. It traded at 16 times analyst earnings estimates at Monday’s close, versus 17.7 for the S&P 500. The Topix closed little changed in Tokyo on Tuesday.

Monetary Base

The Bank of Japan is increasing the monetary base as it seeks to spur higher prices and wage growth. That policy has helped depress the yen and sent profit at companies on the Nikkei 225 Stock Average to all-time highs. As the nation’s economy seeks its footing, the central bank will need to increase stimulus, says Mizuho Asset Management Co.’s Seiichiro Iwamoto.

By contrast, the Fed stopped buying bonds last year and traders expect it to raise interest rates for the first time since 2006 before the end of this year. They see a 46 percent probability it will do so next month.

With quarterly earnings in from most Topix companies, forecasts indicate profit growth will average 8.6 percent in 2015 and 12.2 percent the following fiscal year, according to Jefferies Group LLC. That outpaces an expected 0.9 percent expansion in S&P 500 earnings this year and a 10.7 percent increase in 2016, according to data compiled by Bloomberg.

“Japanese companies are still inexpensive despite the market appreciation,” said Matt Estes, a strategist for the $54 billion BlackRock Global Allocation Fund Inc. “We’ve been taking profits in the U.S. and are concerned that corporate profitability may be near a cyclical peak.”

‘Want to Buy’

Better earnings prospects and easy monetary policy aren’t the only support Japan bulls see. New business codes urge shareholders to press for higher returns and require companies to justify tying up capital in stocks of business partners.

The changes are “what we want to see and what we want to buy,” said Adrian Zuercher, head of Asia asset allocation in Hong Kong at UBS Group AG’s wealth management unit.

Japanese firms will return more cash to shareholders through dividends and buybacks next year than at any time since at least 2006, Goldman Sachs Group Inc. estimates show. Buybacks announced in the quarter ended June totaled 2.1 trillion yen, up 41 percent from a year earlier, according to Nomura Holdings Inc.

“The return on investor capital in Japan is only just getting started,” said Alva Devoy, Sydney-based investment director at Fidelity Worldwide Investment, which oversees $285 billion in assets. “For the U.S., I’m quite concerned about its ability to outperform.”

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