Japanese Stock Market Outlook

SMAM monthly comments & views - March 2016 -

Japanese Economy

The global negative head wind continues and Japanese economy is starting to show some fragilities notably in manufacturing sectors. Private consumption was weak in 4Q 2015 partly affected by a warm winter. On the other hand, private capital investment shows resilience especially in non-manufacturing sectors.

• Japanese financial systems are trying to adjust to the new regime of negative interest rate. It requires some time for

judging if this new easing policy could actually stimulate the economy as BOJ intends or confuses financial systems and

economy. Interest rate for individuals would not become negative yet due to the guidance by the government to

financial institutions.

• Strong employment is supportive for the consumers, however, wage increase has not been large enough to stimulate

private consumption. Spring wage negotiation round is currently going on, which could be rather disappointing as

global economic slowdown makes companies more conservative.

Japanese Stock Markets

Lots of variables remain for a considerable time such as US interest rate policy, unfolding effects of negative interest rates in Japan and further monetary & fiscal policies possibly taken by global authorities. Japanese stock market is expected to move within a wide box range with high volatility for the short term.

• Since Abenomics started, PER for Japanese stock market, in TOPIX index, has been in a range between 12.5x and 16x.

The recent low of 1196.28 in TOPIX reached on 12th February seems at oversold level. At 1180 in TOPIX, PBR is 1.0

times and some downside protection could start to work under this level.

• Due to accumulating cash and low share prices, large share buybacks have been announced by companies, which is

surely positive for the stock market in the long run. Negative interest rate should make it even harder for companies to

justify huge amount of idling cash.

Executive summary

1

Notes: Macro and market views are as of Feb.15th and 17th 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

GDP forecast was downgraded for FY2015 and FY2016 both from +1.0%. Private consumption has been

weaker than previously forecast whereas private capital investment was revised upward due to recent

solidness.

Preliminary forecast was set for FY2017 and this weak forecast was due to estimated aftershock of

consumption tax hike scheduled in April 2017. There is a possibility for postponing this tax hike again if

sluggishness continues for Japanese and global economies.

Notes: E=SMAM forecasts. SMAM views are as of Feb. 15th, 2016 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)

SMAM economic outlook for FY15-17

Real GDP growth 0.9% 2.0% -1.0% 0.8% 0.9% -0.2%

Private Consumption Expenditure 1.7% 2.3% -2.9% -0.3% 1.2% -0.7%

Private Housing Investment 5.7% 8.8% -11.7% 2.1% 2.1% -3.9%

Private Capital Investment 0.9% 3.0% 0.1% 2.2% 2.6% -1.3%

Public Consumption Expenditure 1.5% 1.6% 0.1% 1.3% 1.0% 0.8%

Public Capital Investment 1.0% 10.3% -2.6% -1.3% -1.6% 0.3%

Net Exports (contrib. to GDP growth) -0.8% -0.5% 0.6% 0.1% 0.0% 0.2%

Exports -1.4% 4.4% 7.8% 0.6% 2.7% 2.9%

Imports 3.6% 6.7% 3.3% 0.1% 3.1% 1.7%

Nominal GDP 0.0% 1.7% 1.5% 1.9% 0.9% 0.9%

GDP Deflator -0.9% -0.3% 2.5% 1.1% -0.1% 1.2%

FY15E FY17EFY12 FY13 FY14 FY16E

4

GDP in 4Q 2015 was -0.4% QoQ, which was -1.4% annualized. Private consumption detracted by -0.8% QoQ,

for which warm weather was partly blamed for weak consumption on winter clothes and other seasonal items.

Private capital investment is a bright spot with QoQ growth of +1.4%. in 4Q.

SMAM economic outlook for FY15-16

Notes: SMAM views are as of Feb.15th, 2016 and subject to updates thereafter without notice. Source: Cabinet Office, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts .

-20

-15

-10

-5

0

5

10

13Q1 Q2 Q3 Q4 14Q1 Q2 Q3 Q4 15Q1 Q2 Q3 Q4 16Q1 Q2 Q3 Q4 17Q1

Private Consumption

Private Housing Investment

Private Capital Investment

Public Investment

Others

Net Export

Real GDP

Forecast by SMAM

(QoQ % annualized) Real GDP and contribution by components

Industrial production is recovering though estimate for 1Q 2016 might be optimistic

Industrial production has been rather resilient considering slowing-down global economies.

Estimated index tends to be optimistic from the recent experience and 1Q 2016 could be revised downward.

5

-1.4%-1.2%

0.5%

3.9%

-4 %

-3 %

-2 %

-1 %

0%

1%

2%

3%

4%

5%

6%

7%

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

12 13 14 15 16

Others

Material

Transportation equipment

Machinery

IT goods

Total Industrial Production

Industrial Production Index and contribution by sectors

(Source) Ministry of Economy, Trade and Industry

(QoQ %)

Note: Estimated Index from Jan. 2016 are used.

Estimated index from Jan. 2016.

6

Machinery orders from non-manufacturing industries show resilience

Manufacturing industries are negatively affected by global economic slowdown.

Appetite for capital investment in non-manufacturing industries stays high, which is also witnessed in this

statistics. Transportation sector is making the largest contribution for the recent machinery orders.

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

6,000

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 101112 1 2 3 4 5 6 7 8 9 101112

12 13 14 15

(00' million yen)

Machinery orders from Non-manufacturing and Manufacturing industries

(Source) Cabinet Office

Note: *Green lines are 3 month moving average for each data.Non-manufactuing excludes ship builiding & electric power.

Non-manufacturing

Manufacturing

7

Consumers sentiment has been rather weak since last summer despite strong employment

Consumer sentiment declined last summer due to such negative factors as rising prices and rainy weather, and

then global economic slowdown and falling stock prices.

Strong employment is supportive for the consumers, however, wage increase has not been large enough to

stimulate private consumption. Spring wage negotiation round is currently going on, which could be rather

disappointing as global economic slowdown makes companies more conservative.

30

35

40

45

50

55

60

65

Jan

Ma

r

Ma

y

Jul

Se

p

Nov

Jan

Ma

r

Ma

y

Jul

Se

p

Nov

Jan

Ma

r

Ma

y

Jul

Se

p

Nov

Jan

Ma

r

Ma

y

Jul

Se

p

Nov

Jan

Mar

Ma

y

2012 2013 2014 2015 2016

Economy Watchers DI (for future conditions)

Employment

Household activity

Notes: Diffusion indices of "Economy Watchers Survey". DI above 50 means condition is expected to improve.Source: Cabinet Office

8

Regular wage increase is a supportive but not fast enough to offset inflation

Regular wage has been increasing since the beginning of 2015, which is encouraging.

When inflation was adjusted, real wage for 2015 slightly declined though it could have been distorted by large

decline of bonuses in June 2015, for which statistical error caused by changing sample families was a possibility.

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

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 101112 1 2 3 4 5 6 7 8 9 101112

12 13 14 15

Overtime etc

Bonus

Regular wage

Tot cash wage payment YOY%

Cash wage payment and contribution by components（YOY %）

(Source) Ministry of Health, Labor and Welfare

Outlook for Japanese Stock Markets

9

Stock market outlook: waiting for a confirmation of global economic recovery

SMAM short-term view Uncertainties surrounding the stock market will linger for some time, Chinese economy, Oil price, US slowdown,

strong yen, possible earnings setback and so on. Japanese stock market is expected to move within a wide box range with high volatility for the short term.

Longer-term outlook (6-months and beyond) Lots of variables remain for a considerable time such as US interest rate policy, unfolding effects of negative

interest rates in Japan and further monetary & fiscal policies possibly taken by global authorities. When global uncertainties are gradually cleared, especially the Chinese economy, the Japanese stock market

will make recovery and start to build grounds for the upside trial.

Note: SMAM’s Projection is as of Feb. 17th 2016 and subject to updates without notice

10

700

900

1,100

1,300

1,500

1,700

1,900

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

Jan-1

6

Feb

-16

Ma

r-1

6

Apr-

16

Ma

y-1

6

Jun-1

6

Jul-1

6

Aug-1

6

Sep-1

6

Oct-

16

No

v-1

6

De

c-1

6

TOPIX

Forecast range upside

Forecast range downside

TOPIX index forecast range by SMAM

(Source) TOPIX: Tokyo stock exchange, Forecast by SMAM

(Points)

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views:

• Global economy does not enter into a recession.

• Japan’s private consumption to grow mildly supported by wage growth.

• Japanese corporate earnings keep growing at higher pace than in peer countries.

• Reflationary policy to be continued toward the next consumption tax hike.

Upside Risks include:

• Stronger-than-expected global growth.

• Stronger-than-expected measures by Abe government.

Downside Risks include:

• Unexpectedly large impact from the process of US monetary policy normalization.

• Concern over emerging economies including China.

• Falling oil price causes disastrous problem for oil producing countries.

• Increasing geopolitical concerns.

11

12

According to IBES, analysts are forecasting EPS to grow by 11.9% in the 12 months forward, however,

downward revision will be made.

Global economic slowdown and strong yen are weighing on companies. According to Nikkei

newspaper, Apr-Dec 2015 recurring profit grew +5.9% YOY. Profit forecast by companies for entire

FY2015 was to grow by +2.3% for all listed companies having fiscal year end in March excl. financials.

Profit forecast by companies could be a little conservative, however, uncertainty for the corporate

earnings could undermine the reliability of stock valuations.

Earnings growth is expected to continue for Japan

98

109

11.9%

0%

10%

20%

30%

40%

50%

60%

70%

0

20

40

60

80

100

120

11/01 12/01 13/01 14/01 15/01 16/01

IBES EPS consensus forecast for TOPIX

Historical EPS (left) 12M Forward EPS forecast (left) 12M forward forecast growth (right)

Up to Feb 15th, 2016(Source) Datastream, IBES

0

10

20

30

40

50

60

70

80

90

100

0

2

4

6

8

10

12

14

16

18

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

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

Share Buyback Total（LHS）

Aggregate Dividends（LHS）

Total Shareholders Return（RHS）

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

13

Increasing share buybacks should be supportive for the share prices in the long term

13

Due to accumulating cash and low share prices, large share buybacks have been announced by companies,

which are surely positive for the stock market in the long run.

Negative interest rate should make it even harder for companies to justify huge amount of idling cash.

Forecast

Current PER indicates the stock prices have already discounted lots of pessimism

Since Abenomics started, PER for Japanese stock market, in TOPIX index, has been in a range between 12.5x

and 16x. The recent low of 1196.28 in TOPIX seems at oversold level.

At 1180 in TOPIX, PBR is 1.0 times and some downside protection could start to work under this level.

14

300

500

700

900

1,100

1,300

1,500

1,700

1,900

Ja

n-0

7M

ar-

07

Ma

y-0

7Ju

l-0

7S

ep-0

7N

ov-0

7Ja

n-0

8M

ar-

08

Ma

y-0

8Jul-0

8S

ep-0

8N

ov-0

8Ja

n-0

9M

ar-

09

Ma

y-0

9Ju

l-0

9S

ep-0

9N

ov-0

9Ja

n-1

0M

ar-

10

Ma

y-1

0Ju

l-1

0S

ep-1

0N

ov-1

0Ja

n-1

1M

ar-

11

Ma

y-1

1Ju

l-1

1S

ep-1

1N

ov-1

1Ja

n-1

2M

ar-

12

Ma

y-1

2Ju

l-1

2S

ep-1

2N

ov-1

2Ja

n-1

3M

ar-

13

Ma

y-1

3Ju

l-1

3S

ep-1

3N

ov-1

3Ja

n-1

4M

ar-

14

Ma

y-1

4Ju

l-1

4S

ep-1

4N

ov-1

4Ja

n-1

5M

ar-

15

Ma

y-1

5Jul-1

5S

ep-1

5N

ov-1

5Ja

n-1

6M

ar-

16

Notes: TOPIX: calender year and week-end, P/E ratio is based on 12-month forward EPS of IBESSource: TOPIX: Tokyo Stock Exchange, 12 month forward EPS of IBES: SMAM

TOPIX

Data is up to Feb. 12th 2016 when TOPIX was 1196.28.

TOPIX and PER based on 12-month forward EPS

16x

12x

13x

14x

15xPM Abe's 2nd term started

Short term investors such as hedge funds seem to be taking a heavy short positions

Cash & carry arbitrage position is the amount of cash shares bought as a paring with short positions in

derivatives. It is regarded as an indicator for activities of short term investors such as hedge funds.

After the turn of the year, this arbitrage position has declined sharply, which indicates short term investors are

heavily selling Japanese equities using derivatives.

15

8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

0

1,000

2,000

3,000

4,000

5,000

6,000

Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

Cash and Carry Balance and Nikkei Average

C&C Balance (JPY bn, LHS) Nikkei Avg. (JPY, RHS)

(Source) BloombergUp to Feb. 12th, 2016

(yen billion) (yen)

500

700

900

1100

1300

1500

1700

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb

Net purchasing of Japanese equities by investor type

Foreign Trust bank Individual Inv. Trust Fund Business corp TOPIX

2015

TOPIX (points)

Bar charts (Yen billion)

(Source) Japan Exchange Group

Note: Data is for Tokyo stock exchange and Nagoya stock exchangeUp to Feb. 12th 2016

2016

Supply-Demand balance: Foreign investors selling is pulling the stock prices down

Foreign investors have sold 2.2 trillion yen of Japanese listed shares this year out-powering domestic investors’

purchasing.

In the exchange traded futures, foreign investors sold 1.2 trillion yen in January, however, bought approx. 1

trillion yen in February up to 12th.

16

Could negative interest rate cause shift in huge household assets in Japan?

In Japan, as much as 53% of huge household assets are held in cash and deposits with minimal yields.

Interest rate for individuals would not become negative yet due to the guidance by the government to financial

institutions, however, individuals might start looking for more yield for their assets.

On the other hand, if negative interest rate confuses financial systems and uncertainty deepens, individuals

could be discouraged to take risks for their savings.

17

53%

14%

34%

2%

5%

4%

5%

13%

9%

10%

34%

17%

26%

32%

33%

4%

3%

3%

0% 20% 40% 60% 80% 100%

Japan

Unites States

Euro area

Currrency & deposites Bonds Investment trusts

Shares & equities Insurance & pension reserves Others

Household financial assets breakdown

Note: Data for Japan & US is Sep. 2015 and for Euro area, Jun. 2015.(Source) Bank of Japan

Total1,684 trillion yen

Total68.9 trillion dollars

Total21.7 trillion euro

18

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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.

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