Japan's Top Market Forecaster Sees a Brief Surge

The only strategist to predict the rally and subsequent decline in Japanese stocks last year now says the Topix index will climb 18 percent in the next six months. Kathy Matsui, chief Japan equity strategist for Goldman Sachs (GS) in Tokyo, is telling clients to buy automakers and technology producers because profits will rise as the yen retreats against the dollar.

Matsui is bullish even after confidence among the nation's largest manufacturers fell for the first time since March 2009, as unemployment climbed and executives' reluctance to invest pushed cash reserves to an all-time high. "Many investors make the mistake of becoming too emotionally hung up on Japan's structural problems, and therefore they miss the cyclical opportunities," says Matsui, 45. Japanese stocks rallied 39 percent from March to August 2009, for example. "If you have the stars aligned with a better U.S. economy, a weaker yen, earnings going back to 2007 peaks, and very underweight foreign investors," she says, "that could easily deliver 15 to 20 percent."

In a year when forecasters in Japan were wrong by an average of 21 percentage points, Matsui's December 2009 projection that the Topix would rise to 1050 in the first half of 2010 then fall to 800 stood out. The index advanced 10 percent, to 998.90, by Apr. 15, then retreated 20 percent, to 803.12, on Nov. 2.

Her forecast for 2011 follows a similar pattern. The index of 1,663 Japanese companies will rise 20 percent, to 1080, in the next six months, she says. One reason is that the yen will decline against the dollar as economic growth in the U.S. picks up. A weaker yen helps Japanese manufacturers by making their products more affordable around the world. On Nov. 1 the yen hit 80.22 to the dollar, the strongest level since April 1995. By Jan. 4 the yen had fallen 2.2 percent, to 82.06. For every one-yen decrease vs. the dollar, companies in the Nomura 400-stock index gain 0.5 percent of their recurring profit, according to Takashi Ito, a strategist at Nomura Securities. He said income at automakers and software developers will benefit the most, rising 2.5 percent and 2.3 percent, respectively, for every one-yen decline.

The index will slump to 1000 in the second half of the year, Matsui says. She expects investors to shift money to faster-growing Asian markets such as China once policymakers in those nations curb inflation.

The average forecast from strategists at eight banks surveyed by Bloomberg, including Morgan Stanley and Credit Suisse Group, was for Japanese stocks to gain 20 percent last year. The index instead slumped 1 percent as the yen surged 15 percent against the dollar, cutting the value of profits for Japan's exporters. Strategists forecast the country's shares will advance 15 percent in 2011, based on the average estimate from nine banks tracked by Bloomberg.

Byron Wien, the Blackstone Advisory Services vice-chairman who called Japan stocks one of the best bets for 2010 last January, says he's "neutral" after Bank of Japan policies to stimulate economic growth failed to reverse 20 months of deflation. "I have been disappointed by Japan," says Wien. Matsui, a California native and Harvard graduate who first visited Japan on a scholarship to Kobe University in 1986, favors companies with the highest proportion of U.S. sales. Nikon and Bridgestone are among 31 stocks she likes because they may benefit from American shoppers buying more cars, computers, and cameras.

Nikon, which gets more than 30 percent of its revenue from North America, rose 15 percent from Nov. 1 to Jan. 4. Shares advanced even after the Tokyo-based maker of cameras and lenses reduced its annual profit forecast on Nov. 4. Bridgestone, the world's largest tiremaker, gained 13 percent. The Tokyo-based company, which got 43 percent of its revenue from North and South America last year, rose amid record rubber prices. "Japan has a way of having these short spurts of outperformance," says Matsui. "If you don't catch the wave quickly, you can miss it."

The bottom line: While Japan's economy remains troubled, Matsui says stocks will rally strongly in the next six months thanks in part to the weaker yen.

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