Strategists Shun Aging U.S. Bull Market for a New One in Japan

  • Morgan Stanley upgrades Japan stocks, downgrades U.S. equities
  • One of year’s worst performers becomes a strategist favorite

Japanese Equities: Further Upside to Go?

Strategists are coming around to the idea that Japan is the place to be in 2017, with Morgan Stanley the latest to embrace one of the year’s biggest comeback stories at the expense of America’s aging bull market.

Morgan Stanley joins Japan’s largest brokerage Nomura Holdings Inc. in saying that the country’s bull run will continue into 2017 and recommends selling U.S. shares to fund the trade. It’s a dramatic turnaround after investors fled one of the worst performing markets earlier this year as traders lost faith in Abenomics. The Topix index has rallied for a 12th straight day to the highest level since January.

“The gains in a plausible bull case look larger than before, fueled by the prospect of fiscal expansion, rising earnings and a return of true animal spirits,” according to a 43-page report dated Nov. 27 from the U.S. bank’s cross-asset strategy team led by Andrew Sheets.

It’s that time of the year when investors and analysts dust off their crystal balls and prognosticate on the direction of a multitude of securities. Japan’s Topix may climb as much as 24 percent in 2017 as earnings-per-share expands faster than any other region in the world, according to Sheets. Norikazu Akedo, a senior managing director at Nomura’s brokerage unit, predicts the Nikkei 225 Stock Average will rise as much as 14 percent above Friday’s close of 18,381.22, according to a forecast issued Nov. 18.

Morgan Stanley’s position on Japan is part of the firm’s broader strategy to cut credit exposure and sell equities in the U.S. and emerging markets, a reversal of its previous advice. Investors should also buy shares in Europe, where earnings are seen recovering, said Sheets. He’s keeping more in cash and telling clients that volatility in markets over the next three months may require investors to act even faster than usual.

“Japan becomes our top market, with attractive long-run valuations, some cyclical strength” and good earnings growth prospects, according to the U.S. bank.

The Topix slumped 19 percent in the first half of 2016 as the yen gained and investors lost confidence in Prime Minister Shinzo Abe’s ability to bolster economic growth. While global funds sold a net $56 billion of Japanese stocks through the end of September, they’ve since purchased $14.9 billion this quarter, data compiled by Bloomberg show.

Bullish Stance

The premise of Morgan Stanley’s bullish stance comes from an expectation for further weakness in the yen, stronger-than-consensus growth in Japan’s economy and a firmer global economic expansion. The Topix index is still down 5 percent in 2016, despite a 23 percent surge from its lows in February. The gauge closed little changed on Tuesday.

Strong U.S. economic data and the prospect of increased spending under Trump have fueled a surge in bets on Federal Reserve interest-rate increases, sparking gains in the dollar and shares in the U.S., where all four major equity benchmarks have reached records. The S&P 500 Index trades at 17 times projected 12-month earnings, compared with 14 for the Topix.

Trump’s policy pledges are also bullish for Japanese share prices, which will build on their recent gains in 2017, according to Nomura’s Akedo. His election win was a “great turning point” for Japan equities, due to his commitments to invest in infrastructure and cut taxes, he said. 

Morgan Stanley cut its recommendation on U.S. shares to neutral from overweight, while lifting Japan to overweight from underweight. It also trimmed emerging-market stocks to underweight from neutral.

In terms of earnings, corporate profit growth looks set to accelerate next year, with Japan and Europe leading the way, according to the Morgan Stanley report.

“Over the last five years, the U.S. market has been responsible for much of the heavy lifting when it comes to global earnings growth,” Sheets said. “With the potential benefit to U.S. earnings from lower corporate taxes and greater fiscal expenditure unlikely to come through meaningfully until 2018, next year is likely to see Japan and Europe lead the global earnings recovery.”

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