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Japanese Stock Market Outlook SMAM monthly comments & views - December 2016 -

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Japanese Stock Market Outlook

SMAM monthly comments & views - December 2016 -

Japanese Economy

SMAM revised GDP growth forecast for both FY2016 and FY2017 upward by +0.2% due to stronger than expected recent statics and considering pro-economic growth policies expected by Trump presidency. Forecast for Industrial Production in FY2017 was revised to robust +3.3% from the previous forecast of +2.7%.

• TPP is going to be scrapped at the hands of the Trump presidency, a significant blow to PM Abe’s growth strategy. China is

by far the largest counterpart of US trade deficit, however, extremely hawkish trade policy by US could still dent NAFTA

countries, Japan, EU and emerging economies.

• Bond yields have sharply spiked almost globally after the US election results in November, which caused steepening of yield

curves. Japanese government bond is also facing upward pressure on JGB yields, which Bank of Japan is trying to contain

by intervening in the JGB market. Bank of Japan has placed an unlimited amount of JGB purchasing order at fixed rate for

the first time on Nov. 17th.

Japanese Stock Markets

Trump honeymoon rally is going on in equity markets of advanced economies and US$ inspired by anticipated pro-business and pro-economic-growth policies. This trend could continue until the inauguration of US President Trump in January 2017. After starting Trump presidency, confrontational foreign policies and effects on global financial markets are going to be evaluated.

• Japanese equities will be supported by improving fundamentals in the long-term. Industrial production is gaining strength

and private consumption is recovering. Corporate earnings momentum has turned upward in Jul-Sep quarter. Japanese

companies are assuming around 102 USD/yen for FY2016, which is lower than current rate above 110 and could lead to

substantial earnings up-revisions going forward.

• Japanese government started tackling notoriously long working hours and inefficient working practices in Japan. This could

revive hope for social reform and PM Abe’s growth enhancing strategy, which virtually lost credibility among investors.

Executive summary

1

Notes: Macro and market views are as of Nov 16th and 18th , 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

SMAM revised GDP growth forecast for both FY2016 and FY2017 upward by +0.2% due to stronger than

expected recent statics and considering pro-economic growth policies expected by Trump presidency.

CPI forecast for FY2017 was slightly up-revised from +0.3% to +0.5%.

Forecast for Industrial Production in FY2017 was revised to robust +3.3% from the previous forecast of +2.7%.

Notes: E=SMAM forecasts. SMAM views are as of Nov. 16th , 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 FY16-17

( YoY %)

Real GDP growth 0.9% 2.0% -0.9% 0.9% 0.9% 0.9%

Private Consumption Expenditure 1.7% 2.3% -2.9% -0.1% 0.6% 0.5%

Private Housing Investment 5.7% 8.8% -11.7% 2.4% 6.1% -0.1%

Private Capital Investment 0.9% 3.0% 0.1% 2.1% 0.4% 1.0%

Public Consumption Expenditure 1.5% 1.6% 0.1% 1.6% 1.2% 1.1%

Public Capital Investment 1.0% 10.3% -2.6% -2.7% 0.3% 5.5%

Net Exports (contrib. to GDP growth) -0.8% -0.5% 0.6% 0.1% 0.3% 0.2%

Exports -1.4% 4.4% 7.9% 0.4% 0.4% 2.3%

Imports 3.6% 6.8% 3.4% 0.0% -1.2% 1.2%

Nominal GDP 0.0% 1.7% 1.5% 2.3% 1.1% 1.3%

GDP Deflator -0.9% -0.3% 2.5% 1.4% 0.1% 0.4%

Industrial Production -2.7% 3.0% -0.4% -1.4% 0.9% 3.3%

CPI (excl. fresh food) -0.2% 0.8% 0.9% -0.0% -0.3% 0.5%

FY15 FY17EFY12 FY13 FY14 FY16E

4

Effects of Trump policies on Japan

Positives

• Expansionary economic policy such as fiscal spending and

tax reduction, to lift US and then global economic growth.

• Political gridlock is going to ease as the party of the

President Elect takes majority of both houses in US

Congress.

Negatives

• Global free trade could be hampered causing downward

pressure on global economic growth. TPP(Trans Pacific

Partnership) is now unlikely to be ratified by US.

• Spillover of “Populism” to Europe could cause harmful

effects on global economic growth.

Uncertain

• Policy toward Asia region: Policy of international trade and national security. Any wobbling of US-Japan alliance could be

negative. Seemingly successful first meeting between PM Abe and Mr. Trump on 17th November was positive.

• Whether US dollar strengthening, currently going on, can be admitted by Trump presidency.

• Whether political wheels of Trump presidency and US congress move in good tunes.

Global financial market has switched to “Risk-on” mode after the result of US election won by Mr. Trump.

Trump polices are pro-growth, pro-business and inflationary in US domestic side, which has boosted US stock

markets and bond yields.

Japanese stock market has received a tailwind meanwhile upward pressure on yields of Japanese government

bonds has been countered by Bank of Japan trying to keep yields low.

SMAM views as of Nov. 18th

5

How protectionist the US trade policy could become?

TPP is going to be scrapped at the hands of the Trump presidency, a significant blow to PM Abe’s growth

strategy.

China is by far the largest counterpart of US trade deficit, however, extremely hawkish trade policy by US could

still dent NAFTA countries, Japan, EU and emerging economies.

(Source) IMF, Bloomberg, compiled by SMAM

Counterparts US trade deficits in 2015 (USD mil) Share

1 China 337,014 43.8%

2 Mexico 89,259 11.6%

3 Germany 74,572 9.7%

4 Japan 62,798 8.2%

5 Canada 49,802 6.5%

6 Vietnam 30,214 3.9%

7 Ireland 29,029 3.8%

8 Italy 28,265 3.7%

9 Korea 27,616 3.6%

10 India 24,040 3.1%

Bank of Japan is facing a test of its “yield curve control” policy

Bond yields have sharply spiked almost globally after the US election results in November, which caused

steepening of yield curves.

Japanese government bond is also facing upward pressure on JGB yields, which Bank of Japan is trying to

contain by intervening in the JGB market. Bank of Japan has placed an unlimited amount of JGB purchasing

order at fixed rate for the first time on Nov. 17th.

6

0

0.5

1

1.5

2

2.5

3

US

Germany

Japan

Government Bond Yield Spread (10Y-2Y)(%)

Note: Weekly data from Jan. 10th, 2014 to Nov. 18th, 2016

(Source) Datastream

(Month/Year)

Inventory / shipment cycle shows the production has entered in an expansion phase

The chart is supposed to show anticlockwise movement.

YoY Inventory growth started to fall since March 2015 and has shifted to an expansion phase by crossing the 45

degree line from left to right.

7

Note: Data period from Jan. 2013 to Sep. 2016

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

-8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 8.0

Inventory

(YoY %)

Shipment

(YoY %)

Apr. 2016

Jan. 2014

Sep. 2014

Inventory / shipment cycle chart for manufacturing industries

( 3 months moving average)

(Source) Ministry of Economy, Trade and Industry

Apr. 2015

Sep. 2016

Adjustment phase

Expansion phase

8

Wage keeps mildly rising in Japan

Since the beginning of 2015, regular wage payment has been mildly rising, which is supportive for consumer

sentiment and private consumption.

PM Abe has requested the industry leaders for raising regular wages at the Spring Wage Negotiation Rounds

for FY 2017.

(year) -3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9

2013 2014 2015 2016

Overtime etc

Bonus

Regular wage

Tot cash wage paymentYOY%

Cash wage payment and contribution by components(YOY %)

(Source) Ministry of Health, Labor and Welfare ( Month/Year)

Outlook for Japanese Stock Markets

9

Stock market outlook: What could happen after the current Trump honeymoon rally ?

SMAM short-term view Trump honeymoon rally is going on in equity markets of advanced economies and US$ inspired by anticipated

pro-business and pro-economic-growth policies. This trend could continue until the inauguration of US President Trump in January 2017. After starting Trump presidency, confrontational foreign policies and effects on global financial markets are going to be evaluated.

Longer-term outlook (6-months and beyond) Japanese equities will be supported by improving fundamentals in the long-term. Industrial production is

gaining strength and private consumption is recovering. Corporate earnings momentum has turned upward in Jul-Sep quarter. Japanese companies are assuming around 102 USD/yen for FY2016, which is lower than current rate above 110 and could lead to substantial earnings up-revisions going forward.

Note: SMAM’s projection is as of Nov. 18th,, 2016 and subject to updates without notice

10

700

900

1,100

1,300

1,500

1,700

1,900

Ja

n-1

4

Fe

b-1

4

Ma

r-1

4

Ap

r-1

4

Ma

y-1

4

Ju

n-1

4

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Au

g-1

4

Se

p-1

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Oct-

14

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5

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r-1

6

Ap

r-1

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6

Ju

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6

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6

Au

g-1

6

Sep-1

6

Oct-

16

No

v-1

6

De

c-1

6

Ja

n-1

7

Fe

b-1

7

Ma

r-1

7

Ap

r-1

7

Ma

y-1

7

Ju

n-1

7

Ju

l-1

7

Au

g-1

7

Sep-1

7

Oct-

17

No

v-1

7

De

c-1

7

TOPIX

Forecast range upside

Forecast range downside

TOPIX index forecast range by SMAM

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

(Points)

(Month/Year)

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 growth to gradually recover from the negative shock of stronger yen.

• Fiscal stimulus and further monetary easing will be made to sustain economic growth in Japan.

Upside Risks include:

• Stronger-than-expected global growth.

• Stronger-than-expected measures by the Abe government.

Downside Risks include:

• Confrontational foreign policies taken by Trump presidency shake global trades and deepen geo-political

tensions.

• Populism gains in Europe further stabilizing EU.

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

• Concern over emerging economies including China.

11

SMAM’s forecasts as of November 2016

12

Sharp strengthening of US$ has made US equities as the single winner in US$ terms

12

After the US presidency election won by Mr. Trump, US$ has strengthened quite substantially. Comparing

major equity markets in US$ terms, US is the only market to have gained in November as of 24th.

Even solid rise in TOPIX in yen terms has not been enough to compensate sharp decline of yen against US

dollars. Emerging market equities are suffering from cash outflow.

It is still uncertain how far this strong US$ can be sustained considering hawkish trade policy expected from

Trump presidency.

70

75

80

85

90

95

100

105

110

115

120 MSCIEM/US$

S&P500

TOPIX/US$

MSCIEurope/US$

TOPIX/Yen

US$ based performance of stock markets (Dec 2015 =100)

(Source) Datastream, MSCI and Tokyo Stock Exchange, compiled by SMAM.

Notes: Month-end data from Dec 2015 to Oct 2016. Nov. 2016 data is as of 24th.

(Month/Year)

Political stability is an valuable asset for Japan

Approval rating for PM Abe’s cabinet was 55% in November, which was comfortably high when many countries

are suffering political instabilities.

Japanese government started tackling notoriously long working hours and inefficient working practices in Japan.

This could revive hope for social reform and PM Abe’s growth enhancing strategy, which virtually lost credibility

among investors.

13

0

10

20

30

40

50

60

70

80

90

Aug-9

8

Feb

-99

Aug-9

9

Feb

-00

Aug-0

0

Feb

-01

Aug-0

1

Feb

-02

Aug-0

2

Fe

b-0

3

Aug-0

3

Feb

-04

Aug-0

4

Feb

-05

Aug-0

5

Feb

-06

Aug-0

6

Feb

-07

Aug-0

7

Feb

-08

Aug-0

8

Fe

b-0

9

Aug-0

9

Feb

-10

Aug-1

0

Feb

-11

Aug-1

1

Feb

-12

Aug-1

2

Feb

-13

Aug-1

3

Feb

-14

Aug-1

4

Feb

-15

Aug-1

5

Feb

-16

Aug-1

6

Obuchi

Mori

Koizumi

Abe 1

Fukuda

Aso

Hatoyama

Kan

Noda

Abe 2

Approval ratings of Japanese cabinets by Prime Ministers(%)

(Source) NHK

Nov. 55%

Apl. 42%

Current Abe

(Month/Year)

Earnings momentum keeps improving

12M EPS forecast continues improving with the latest leading of 101 for TOPIX in November.

10.1% of 12M forward EPS growth is forecast .

14

%

(month/ year)

92

101

10.1%

0%

10%

20%

30%

40%

50%

60%

70%

0

20

40

60

80

100

120

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

IBES EPS consensus forecast for TOPIX

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

Note: Weekly data from Jan. 4th 2011 to Nov. 15th 2016.

(Source) Datastream, IBES

(Points)

(Month/Year)

PER is in the lower half of the range for the current PM Abe’s tenure

Since Abenomics started, PER for Japanese stock market, TOPIX index-wise, has been in a range between 12x

and 16x except for temporary overshooting.

As of October 14th, PER for TOPX was 13.64x whereas comparative PER for S&P 500 was over 16x. Relative

valuation of Japanese stocks looks attractive compared to US stocks.

15

300

500

700

900

1,100

1,300

1,500

1,700

1,900

Oct-

07

De

c-0

7F

eb

-08

Apr-

08

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ug-0

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ct-

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16

Note: Data is weekly from Oct. 26th 2007 to Nov. 11th 2016. TOPIX was 1378.28 at the end of the period. (Source) Tokyo Stock Exchange, Datastream and IBES, compiled by SMAM

TOPIX

(Month/Year)

TOPIX and PER based on 12-month forward EPS

16x

12x

13x

14x

15xPM Abe's 2nd term started

Foreign investors turned purchasing Japanese equities from October this year

Short covering by foreign investors after the US election ignited the recovery of Japanese stock prices.

Domestic investors have been selling Japanese equities so far except for constant share buybacks by business

corporations.

16

(month/ year)

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 Mar Apr May Jun July Aug Sep Oct Nov

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 exchange up to Nove. 11th 2016.

2016 (Month/Year)

17

Overseas investors money is flowing back to Japanese equities

17

Arbitrage positions of “Long cash equity/Short futures” is referred to as an indicator of activities by overseas

investors, mainly short-term ones.

The outstanding position continued to decline since the beginning of this year, however, started to accumulate

from the middle of September.

8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

Outstanding arbitrage positions: Long cash equities /Short futures

Outstanding arbitrage positions (right) Nikkei 225 index (left)

(yen mil)

(Year/Month/Day)Note: Daily data from Nov. 18th 2014 to Nov. 17th 2016.(Source) Japan Exchange Group.

18

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/indices 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 guarantee its

completeness or accuracy. = All rights, titles and interests in this material and any content contained herein are the exclusive properties of SMAM, except as otherwise stated.

It is strictly prohibited from using this material for investments, reproducing/copying this material without SMAM’s authorization, or from

disclosing this material to a third party.

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