Bulls Are Adamant Unloved Japan Stocks Are Primed For Gains

  • Shares likely to rise on improved fundamentals: MUFJ-MS
  • Topix valuations lag U.S., Europe while profits and GDP grow

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As the Japanese stock market is whipsawed by the latest news on North Korea, sagging support for Prime Minister Shinzo Abe and currency swings, some analysts see recent underperformance as an opportunity to buy.

Japan’s longest string of quarterly economic expansion in more than a decade and continued growth in corporate earnings have emboldened bullish equity strategists. Comparatively low valuations and a rise in dividend yield in the past few months are also helping sentiment, as Tokyo stocks lag far behind the double-digit gains of Asian peers from Hong Kong to Mumbai this year.

“Buying on dips could prove an attractive investment strategy,” wrote Naohiko Miyata, chief technical analyst at Mitsubishi UFJ Morgan Stanley Securities Co., in a note Monday. “Japanese stocks now also have support from company fundamentals, not just technical charts.”

Topix companies beat analyst profit estimates by an average of 15 percent in the latest quarter. Earnings per share rose 27 percent year-on-year, continuing a trend of gradual increases over the past five years. Results have improved despite a strengthening of about 13% in the yen versus the dollar since June 2015.

While profits have risen, the Topix’s price-to-earnings ratio has fallen to 15 times, below the 21 times level where the S&P 500 Index and Stoxx Europe 600 Index are both currently trading. Meanwhile, the Nikkei 225 Stock Average’s 14-day relative strength index fell to 32.3 on Monday, near the level of 30 that some traders see as a sign that shares are due for a rebound.

“We still expect the market to rise as investors recognize sustained earnings improvement,” wrote Chisato Haganuma, chief equity strategist at Mitsubishi UFJ Morgan Stanley, in a report Monday. First-quarter results “have shown sales growth, with help from improved economic growth in Japan and overseas, and cost-cutting stances. On the whole, earnings estimates are being revised upward.”

Not everyone is convinced that Japanese shares are set for gains. Hitoshi Asaoka, a strategist at Asset Management One, sees the Nikkei 225 closing between 19,000 and 20,000 at year-end. Japan’s blue-chip gauge slipped 0.1 percent to 19,702.63 Thursday, paring its year-to-date gain to 3.1 percent.

“It’s difficult for Japanese shares to rise much further from here,” said Asaoka. “The latest GDP numbers were a little too good, and economic growth will probably peak out globally around the summer.”

One factor that has capped gains for Japanese stocks is the negative impact of the stronger yen on buying by foreigners, but “the influence of the yen on profits is far smaller than most investors think,” says Nicholas Smith, a strategist at CLSA Ltd. in Tokyo. The market has also taken a hit from “sabre-rattling” over North Korea and concern over possible challenges to Abe’s leadership, Smith wrote in an Aug. 10 report.

The political turmoil shouldn’t be a problem either way, Smith said. Waning support for the cabinet could pressure Abe to speed labor reform, implement fiscal stimulus and forge trade deals, the CLSA strategist wrote, and even if that fails, “Japan is likely to get a prime minister with very similar economic plans and a revitalized dream.”

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