Japanese Stock Market Outlook

SMAM monthly comments & views

~ December 2014 ~

Japanese Economy

Jul-Sep GDP came out at surprisingly weak headline number of -1.6% QoQ annualized. This was due to inventory cut back by industries. Private consumption started to show recovery, though still fragile, and delaying the next consumption tax hike for 18 months could stimulate consumer sentiment.

• After the unexpectedly weak Jul-Sep figures, SMAM reduced FY14 GDP growth forecast to -0.5% from previous

+0.1%. On the other hand, Forecast for FY15 was raised to 1.4% from previous 1.1% considering simulative

effects from postponing next consumption tax hike.

• Exports turned positive in Jul-Sep and it could help Japanese industries as further weakening of yen is

expected.

Japanese Stock Markets

Surprising move by both BOJ and Abe government inspired a fresh life into the Japanese stock market. Snap election in December will provide Abe led LDP-Komeito coalition with re-strengthened political standings. Size of the supplemental budget spending and wage increase prospect for 2015 spring negotiation round would attract investors’ attention for the short term.

• SMAM’s forecast range for TOPIX is from 1300 to 1460 until December and from 1260 to 1520 for Jan-Mar

2015. Potential further upward earnings revisions on the back of weaker yen and GPIF’s allocation shift to

equities will be supportive for the stock market.

• Risks could be such as slowdown in US economy, heightening geopolitical tensions and Abe led coalition to

face heavy loss in the election.

Executive summary

1

Outlook for the Japanese Economy

2

SMAM economic outlook for FY14-15

3

After unexpectedly weak Jul-Sep figures, SMAM reduced FY14 GDP growth forecast to -0.5% from previous

+0.1%. On the other hand, Forecast for FY15 was raised to 1.4% from previous 1.1% considering simulative

effects from postponing next consumption tax hike.

Jul-Sep GDP was dragged down by inventory cut back by industries. Private consumption started to show

recovery, though still fragile, and delaying the next consumption tax hike for 18 months could stimulate consumer

sentiment.

Exports turned positive in Jul-Sep, which could help Japanese industries as further weakening of yen is expected.

Notes: P=Official preliminary report, E=SMAM forecasts. SMAM views are as at 17 November 2014 and subject to updates thereafter without notice

Source: Cabinet Office: Bank of Japan, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts

(%YoY except Net Exports)

Real GDP 0.3% 0.7% 2.2% -0.5% 1.4%

Private Consumption 1.4% 1.5% 2.5% -2.9% 1.4%

Housing Construction 3.2% 5.4% 9.5% -10.1% 1.9%

Private Capital Investment 4.8% 0.7% 2.6% 1.3% 2.4%

Public Consumption 1.2% 1.5% 1.8% 0.5% 0.8%

Public Investment -3.2% 1.3% 15.0% 4.4% -1.0%

Net Exports (contrib. to growth) -1.0% -0.8% -0.5% 0.6% 0.1%

Exports -1.6% -1.3% 4.8% 6.1% 3.8%

Imports 5.3% 3.6% 7.0% 2.3% 3.6%

Nominal GDP -1.4% -0.2% 1.9% 1.3% 2.4%

GDP Deflator -1.7% -0.9% -0.4% 1.8% 1.1%

FY14E FY15EFY11 FY12 FY13

Quarterly GDP : Inventory cut back by industries dragged Jul-Sep GDP into negative territory

Jul-Sep GDP came out at surprisingly weak headline number of -1.6% (QoQ annualized and the same applies

to the following numbers).

This was due to inventory cut back by industries, which made contribution of -2.6% .

Contribution of private consumption was up by 0.9% and expected to continue mild recovery going forward.

4

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1

12 13 14 15 16

Net exports

Public investment

Private housing investment

Others

Private consumption

Private Capital Investment

GDP

(QoQ % annualized) Real GDP and contribution by components

(Source) Cabinet Office

Forecast by SMAM

"Others" consist of mostly Inventory change.

Inventory rose to a historically high level and had a sharp cut back recently

Monthly statistics show that inventory reached a historically high level in August, which seems to have triggered

a sharp cut back in September.

The progress in inventory adjustments is favorable for industries as increase in production becomes more likely

when recovery in demand takes place.

5

80

90

100

110

120

130

140

150

160

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9

04 05 06 07 08 09 10 11 12 13 14

Inventory level

Inventory/Shipment ratio

Inventory and Inventory/Shipment ratio for all industries(Indexed 100 = 2010 average)

(Source) Ministry of Economy, Trade and Industry

6

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 9

08 09 10 11 12 13 14

Machinery orders

Manufacturer Non-manufacturer Total

Note: Seasonally adjusted. Bar charts are % point contribution to %MoM. Calender yearSource: Ministry of Economy, Trade and Industry, SMAM

(MoM %）

In the GDP statistics, private capital investment has stalled recording -2.8% and -0.1% for Apr-Jun and Jul-Sep

respectively after the sharp increase in Jan-Mar at 4.2 % ( all figures are QoQ annualized contribution).

However, machinery orders have been showing more stable increase in recent months, which could lead to the

recovery in the capital spending in the near future.

Machinery orders seem stabilized after volatile 1H

7

As a silver lining for the Japanese economy, export volume started to increase in Jul-Sep quarter and

accelerated in October helped by US, China and other Asian countries as destinations. Yen is forecast to get

even weaker and increase in exports could be a supporting factor for the Japanese economy.

Increase in exports could offer a helping hand to the Japanese economy

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q

10 11 12 13 14

Others

EU

China

Asia excl. China

US

Total exports

Total export volume (QoQ % change) and contribution by regions(QoQ %)

(Source) Ministry of Finance, compiled by SMAM

4Q

Figure for 4Q 2014 is for October only.

CPI is expected to slow down on the back of diminishing contribution from energy

BOJ surprised the global financial markets by announcing another massive monetary easing in October.

SMAM’s current forecast for CPI is still below BOJ’s target of 2% and BOJ’s nerve might face another test

going forward despite the recent additional easing.

8

-1.80%

-1.60%

-1.40%

-1.20%

-1.00%

-0.80%

-0.60%

-0.40%

-0.20%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

1.80%

1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 1011121 2 3 4 5 6 7 8 9 1011121 2 3 4 5 6 7 8 9 1011121 2 3

11 12 13 14 15 16

Components of Core CPI (excl. fresh food) and forecast（YOY %）

(Source) Ministry of Internal Affairs & Communications, forecast by SMAM.

SMAM Forecast

FY2011 0.0％

FY2012 ▲0.2％

FY2013 +0.8％

FY2014 +1.0％

Note: Excluding direct impact from consumption tax hike in April.

FY2015 +1.0％

Energy

Food

Core CPI (excl. fresh food)

Real wage increase in the next year came into sight after delaying the next tax hike

Regular wage payment increased by 0.5% in September, for four consecutive months since June.

Due to higher inflation, contracting real wage has proved too burdensome for the consumers so far.

Postponing the next round of consumption tax hike paved the way for the increase in real wage in the next year,

which is vital for the Japanese economy to decisively escape from the long standing deflation.

9

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8

10 11 12 13 14

Bonus

Overtime etc.

Regular wage payment

Wage increase

Wage increase and contribution of each component

(Source) Ministry of Health, Labor and Welfare

（YoY %)

9-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

05 06 07 08 09 10 11 12 13 14 15

Real wage Number of employees Real Employee Compensation

Real Employee Compensation and its breakdown(YoY %)

Source: Cabinet Office, Ministry of Internal Affairs and Communications, Ministry of Health, Labour and Welfare . Forecasts by SMAM

SMAM Forecasts

Outlook for the Japanese Stock Markets

10

Stock market outlook: Stimulative policy mix would work positively for the stock market

SMAM short-term view Surprising move by both BOJ and Abe government inspired the fresh life into the Japanese stock market. Snap

election in December will provide Abe led LDP-Komeito coalition with re-strengthened political standings. Size of the supplemental budget spending and wage increase prospect for 2015 spring negotiation round would attract investors’ attention for the short term.

SMAM’s forecast range for TOPIX is from 1300 to 1460 until December and from 1260 to 1520 for Jan-Mar 2015. Potential further upward earnings revisions on the back of weaker yen and GPIF’s allocation shift to equities will be supportive for the stock market.

Risks could be such as slowdown in US economy, heightening geopolitical tensions and Abe led coalition to face heavy loss in the election.

Longer-term outlook (6-month and beyond) For longer-term, we continue to expect the market to track on a modest uptrend, supported by US-led

moderate global growth, solid corporate earnings growth and Japan’s admittedly slow but steady reforms.

Note: SMAM forecasts are as at 19 November 2014 and subject to updates without notice

11

700

800

900

1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700

Jul-1

2

Aug-1

2

Sep-1

2

Oct-

12

No

v-1

2

De

c-1

2

Jan-1

3

Feb

-13

Ma

r-1

3

Apr-

13

Ma

y-1

3

Jun-1

3

Jul-1

3

Aug-1

3

Sep-1

3

Oct-

13

No

v-1

3

De

c-1

3

Jan-1

4

Feb

-14

Ma

r-1

4

Apr-

14

Ma

y-1

4

Jun-1

4

Jul-1

4

Aug-1

4

Sep-1

4

Oct-

14

No

v-1

4

De

c-1

4

Jan-1

5

Feb

-15

Ma

r-1

5

Apr-

15

Ma

y-1

5

Jun-1

5

Jul-1

5

Aug-1

5

Sep-1

5

Oct-

15

No

v-1

5

De

c-1

5

TOPIX

Forecast upper range

Forecast lower range

SMAM forecast range for TOPIX index

(Source) Tokyo stock exchange, forecast by SMAM

(Points)

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views:

• LDP Komeito coalition parties sustain large majority after the snap election in December

• Global economic growth is going to be sustained led by strong US economy

• Japan’s recovery from tax-hit weak demand

• Political supports including reasonably effective growth strategies

• Growing expectations for positive earnings revisions by corporates

Upside Risks include:

• Weaker JPY than a base assumption (USD=JPY118 at CY14 end)

• Stronger global growth

• More powerful measures by Japanese authorities

Downside Risks include:

• Markets to turn around to deeper risk-off mode, should geopolitical tensions grow

• US economy to slowdown

• LDP Komeito coalition parties face heavy loss of lower house seats at the snap election

• Unsatisfactory earnings revisions by companies

12

Snap election is expected to reestablish political standings of PM Abe

After resignation of two newly appointed cabinet ministers on money scandals, approval rating of PM Abe and

his cabinet declined to 44% in November, dangerously close to the historically crucial 40% level.

LDP has approval ratings of 36.6%, still far ahead of the leading opposition party DPJ at 7.9%, whereas 40%

support no party. LDP and Komeito coalition is likely to keep large majority and reestablish its political standings

through the snap election even if losing dozens of seats.

13

44

0

10

20

30

40

50

60

70

80

90

Ap

r-0

0M

ori

Ma

y-0

1K

oiz

um

i

Oct-

06

Ab

e 1

st

Oct-

07

Fu

ku

da

Oct-

08

Aso

Oct-

09

Ha

toya

ma

Ju

n-1

0K

an

Se

p-1

1N

od

a

Ja

n-1

3A

be 2

nd

No

v-1

4

Approval rating of Prime Ministers and Cabinets

(%)

(Source) NHK

Earnings forecasts entered a short lull period after the interim announcements

After the consecutive upward revisions, it entered a lull hovering around the neutral level after most companies

announced interim results.

Japanese yen is getting weaker than the presumption rates on which analysts base their earnings forecasts and

further upward revision can be expected going forward.

14

-40%

-30%

-20%

-10%

+0%

+10%

+20%

+30%

2010 2011 2012 2013 2014

Topix Revision Index

Notes: Revision index= % of Analyst upgrades out of total Topix firms - % of downgrades. Calender year, weeklySource: IBES, SMAM

Up to Nov 14

Japanese stock market looks fairly valued

As of Nov 17 2014, IBES 12 month forward EPS forecast for TOPIX was 96.45. PER range after Abenomics

has been mostly between 13x to 15x, which equals to 1253 and 1446 points for TOPIX index respectively based

on this EPS.

Current Japanese yen level is much weaker than the presumption rate for analysts forecasts and further upward

revision can be expected. SMAM’s current upside of the forecast range for TOPIX until March 2015 is 1520,

which assumes 5% upward EPS revision to 101.27 and 15x PER.

15

300

500

700

900

1,100

1,300

1,500

1,700

1,900

Jan

-07

Mar-

07

May-0

7

Jul-0

7

Se

p-0

7

Nov-0

7

Jan

-08

Mar-

08

May-0

8

Jul-0

8

Se

p-0

8

Nov-0

8

Jan

-09

Mar-

09

May-0

9

Jul-0

9

Se

p-0

9

Nov-0

9

Jan

-10

Mar-

10

May-1

0

Jul-1

0

Se

p-1

0

Nov-1

0

Jan

-11

Mar-

11

May-1

1

Jul-1

1

Se

p-1

1

Nov-1

1

Jan

-12

Mar-

12

May-1

2

Jul-1

2

Se

p-1

2

Nov-1

2

Jan

-13

Mar-

13

May-1

3

Jul-1

3

Se

p-1

3

Nov-1

3

Jan

-14

Mar-

14

May-1

4

Jul-1

4

Se

p-1

4

Nov-1

4

TOPIX vs. Implied levels by PER based on 12-month Forward EPS

TOPIX

PER x16

PER x15

PER x14

PER x13

PER x12

PER x11

Notes: Calender year, week-end Topix, PER base on 12-month forward EPSSource: Tokyo Stock Exchange, IBES 12 month forward EPS, SMAM

(pts)

Up to Nov 17th 2014

16

Forecasts for shareholder returns are revised further upward

SMAM monitors forecasts for shareholder returns every month, which has been showing upward revisions.

Dividends for FY2014 and 2015 were revised upward by 0.2 and 0.3 trillion yen respectively in November from

the previous month.

Social environments are rapidly changing and companies are under pressure for making better management

from shareholder views, which will improve the efficiency of the companies and should be beneficial for

corporate value in the long term. Increasing number of companies are setting ROE targets these days.

16

7.6

6.9

8.2

8.8 9.4

4.3

1.7

1.9

2.8

3.5

36.932.6

37.2 37.8

0

20

40

60

80

100

0

1

2

3

4

5

6

7

8

9

10

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

(JPY tn) Dividend payments & Share buyback by listed firms

Aggregate Dividends (LHS)

Share Buyback Total (LHS)

Div. Payout Ratio* (RHS)

Total Shareholders Return(RHS)

Forecast

FY

(%)

Notes: For ordinary shares of listed firms excluding lossmakers or subsidiariesSource: Toyo Keizai, Quick, I-N Information Systems, Daiwa Securities forecasts

Any material slowdown in global economy could be a risk for the stock market

Observing the monthly movements in the charts below, Japanese stock market might be extended a little

compared to the declining global PMI, which is sustained solely by US.

US PMI has stayed at high level and could be due for a cyclical slowdown in the short term. Pick up in other

countries and regions are much awaited.

17

650

750

850

950

1,050

1,150

1,250

1,350

1,450

44

46

48

50

52

54

56

58

11/12 12/06 12/12 13/06 13/12 14/06

TO

PIX

GLO

BA

L P

MI

GLOBAL PMI & TOPIX

Global PMI TOPIX

(Source) Datastream, Tokyo stock exchange

40

42

44

46

48

50

52

54

56

58

60

11/12 12/06 12/12 13/06 13/12 14/06

PMI of major countries and regions

GLOBAL USA JAPAN EURO CHINA

(Source) Datastream Up to Oct. 2014 Up to Oct. 2014

18

Future selling by overseas investors was swiftly rewound to open a new rally

18

Future selling by overseas investors, which we pointed as a factor behind the correction in the stock market

last month, was swiftly rewound to ignite recent rally in the Japanese stock market.

(40,000)

(30,000)

(20,000)

(10,000)

0

10,000

20,000

30,000

40,000

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

Overseas investors' future positions & Nikkei 225

Nikkei 225 index (LHS)

Overseas Investors cumulative futurepositions (RHS)

up tp Oct 7

YenYen 000' mil

(Source) Tokyo Stock Exchange

19

Disclaimer

Please read this disclaimer carefully. = This material is for non-Japanese institutional investors only. = The research and analysis included in this report, and those opinions or judgments as outcomes thereof, are intended to introduce or

demonstrate capabilities and expertise of Sumitomo Mitsui Asset Management Company, Ltd. (hereinafter “SMAM”), or to provide

information on investment strategies and opportunities. Therefore this material is not intended to offer or solicit investments, provide investment advice or service, or to be considered as disclosure documents under the Financial Instruments and Exchange Law of Japan.

= The expected returns or risks in this report are calculated based upon historical data and/or estimated upon the economic outlook at

present, and should be construed no warrant of future returns and risks. = Past performance is not necessarily indicative of future results. = The simulated data or returns in this report besides the fund historical returns do not include/reflect any investment management fees,

transaction costs, or re-balancing costs, etc. = The investment products or strategies do not guarantee future results nor guarantee the principal of investments. The investments

may suffer losses and the results of investments, including such losses, belong to the client. = The recipient of this report must make its own independent decisions regarding investments. = The opinions, outlooks and estimates in this report do not guarantee future trends or results. They constitute SMAM’s judgment as of

the date of this material and are subject to change without notice. = The awards included in this report are based on past achievements and do not guarantee future results. = The intellectual property and all rights of the benchmarks/indexes belong to the publisher and the authorized entities/individuals. = This material has been prepared by obtaining data from sources which are believed to be reliable but SMAM can not and does not

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otherwise stated. It is strictly prohibited from using this material for investments, reproducing/copying this material without SMAM’s

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As of November 2014