Twenty-five years after its stock market bubble burst, Japan’s slow- growth economy still understandably prompts skepticism from investors. The stars, however, may finally be aligning for Japanese stocks, says Shusuke Yamada, the strategist for Bank of America Merrill Lynch in Tokyo.
For one thing, Japanese stocks are reasonably priced, trading at just under 15 times this year’s earnings forecasts and 13.8 times next year’s expectations. Corporate earnings are predicted to grow 11% this year following 20% growth last year. Yamada has a target of 25,000 for the benchmark Nikkei 225, about 18% above last week’s level. That’s on top of a 19% rise last year (23% in U.S. dollar terms). Add in a 2% annual dividend and global investors can anticipate pretty decent returns.
In another positive for equities, Prime Minister Shinzo Abe’s administration last month nominated Haruhiko Kuroda to a new five-year term as the Bank of Japan governor alongside a reflationist deputy. The message is that there will be a continuation of the easy monetary stance that has helped Japan crawl out of its long deflationary spiral, says Yamada.
And despite a changing global backdrop–more market volatility, higher U.S. bond yields–the outlook for Japan continues to improve. Japan still has attractive valuations and strong earnings growth, says Kathy Matsui, strategist for Goldman Sachs in Tokyo. “Yen appreciation has been one issue, but it is still not too high” at just under 107 yen to the dollar, she says.
Yamada expects the U.S. dollar to strengthen to 115 yen over the year as the Federal Reserve continues to raise rates. That would be a positive for Japanese exporters who are already benefiting from growth in global demand. “Protectionism is another risk, but it won’t derail Japanese equities this year,” he says. The Trump administration fired its first salvo with tariffs on steel and aluminum last week.
Improving domestic demand will help Japanese consumer companies. “We also believe companies that benefit from the improving [capital expenditure] cycle will do well in light of a tightening labor market,” he says. “Japan is running out of people so companies are investing in automation and spending money on IT services to improve productivity,” he says.
Matsui notes that Japanese companies have $940 billion in cash on their balance sheets, which they are likely to deploy by boosting dividends, buybacks, and wages now that they are more confident about the overall outlook. In a deflationary environment, companies tend to hoard cash. “Last year, the market was disappointed that there weren’t as many share buybacks or dividend increases as everyone was hoping for,” she says. Abe has been pleading with companies to raise wages 3%, which would boost consumption and growth. That hasn’t happened, but overall employment income, which takes into account higher labor participation and record participation of women, has been growing.
Janet Flanders Johnston, portfolio manager at TrimTabs Asset Management in New York, says Japanese consumers have 51% of their savings in cash earning virtually nothing. “They have just an 11% allocation to equities right now and at some point more of that goes into equities, which takes the market higher,” she says. One beneficiary she likes: Nomura Holdings (ticker: NMR), one of the world’s largest brokerage firm.