Japanese Stock Market Outlook

SMAM monthly comments & views - June 2016 -

Japanese Economy

Real GDP for Jan-Mar 2016 was +0.4% QoQ, +1.7% when annualized, which was better than forecast. Private consumption was +0.5% QoQ though it was inflated by leap year effects.

• Capital investments, especially from non-manufacturing industries show strength and also manufacturing industries

show some resilience when interpreted by recent machinery orders statistics. Government has set nominal GDP target

of yen 600 trillion in FY2021. Productivity improvement in the service sector is expected to play a key roll with an

ambitious target of 2% per annum improvement.

• Despite recent weakness in consumer spending, fundamentals surrounding households are still solid. Tight labor

market should provide job security and aggregated real wage continues to grow where all three factors, nominal wage,

number of employees and low inflation contributed in March.

Japanese Stock Markets

Negative news on corporate earnings has been completed. There are many events waiting ahead such as next US interest rate hike, possible monetary & fiscal stimulus in Japan, Upper House election in July. High volatility is expected to stay, however, expectation for further stimulus could lift the stock market for the short term.

• Majority of the Japanese companies set 110 yen/dollar rate for the earnings forecast for FY2016. If yen stabilizes

around the current level, further negative currency impact can be avoided, and conservative earnings estimates by

companies can be gradually revised upward.

• Sluggish Chinese economy is likely to continue. US economy shows some strength, however, it makes FED rate hike

more possible. Overseas economy is going to stay patchy. The key for the Japanese economy and stock market will be

what kind and amount of stimulus measures are taken and how effective they turn out.

Executive summary

1

Notes: Macro and market views are as of May 18th and 20th, 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

SMAM’s Real GDP forecast for FY2016 and 2017 are unchanged from the previous month. Recently

announced Jan-Mar GDP of annualized 1.7% was better than preceding forecasts even though inflated by leap

year effects.

Current forecast assumes consumption tax to rise from 8% to 10% in April 2017 as scheduled. Odds for

postponing this tax hike is rising and if it is postponed GDP forecast will be +0.5% for FY2016 and +0.9% for

FY2017.

Notes: E=SMAM forecasts. SMAM views are as of May 18th , 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% -0.9% 0.8% 0.8% 0.2%

Private Consumption Expenditure 1.7% 2.3% -2.9% -0.3% 0.9% -0.3%

Private Housing Investment 5.7% 8.8% -11.7% 2.4% 2.4% -3.9%

Private Capital Investment 0.9% 3.0% 0.1% 1.6% 1.0% -1.3%

Public Consumption Expenditure 1.5% 1.6% 0.1% 1.6% 1.4% 0.8%

Public Capital Investment 1.0% 10.3% -2.6% -2.2% 1.9% 4.0%

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

Exports -1.4% 4.4% 7.9% 0.4% 2.0% 2.9%

Imports 3.6% 6.8% 3.4% -0.1% 2.0% 1.8%

Nominal GDP 0.0% 1.7% 1.5% 2.2% 0.3% 1.3%

GDP Deflator -0.9% -0.3% 2.4% 1.4% -0.6% 1.1%

FY15 FY17EFY12 FY13 FY14 FY16E

4

Real GDP for Jan-Mar 2016 was +0.4% QoQ, +1.7% when annualized, which was better than forecast. Private

consumption was +0.5% QoQ though it was inflated by leap year effects.

Private consumption is forecast to decline in Apr-Jun quarter due to the earthquake in Kumamoto and then

make recovery from Jul-Sep quarter. A rush demand before consumption tax hike and its reversal contraction

are currently included in our forecast for 2017.

SMAM quarterly economic outlook

Notes: SMAM views are as of May 18th,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 .

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

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

2013 2014 2015 2016 2017

Private Consumption

Private Housing Investment

Private Capital Investment

Public consumption expenditure

Public Investment

Net Export

Real GDP

Forecast by SMAM

(QoQ %) Real GDP and contribution by components

Manufacturing side of the Japanese economy requires time for recovery

Industrial production has been declining since 2015, though it made recovery in March from the exceptionally

sharp fall in the previous month due to cuts in Toyota’s production caused by a trouble in a factory of one of its

major suppliers.

Earthquake in Kumamoto is expected to distort manufacturing indicators for Apr-Jun quarter.

Inventory stays at high level despite declining production, which is expected to weigh on the recovery of

manufacturing side of the economy.

5

80

85

90

95

100

105

2010

2011

2012

2013

2014

2015

2016

Industrial production (2010=100)

Note: red line is quarterly numbers.(Source) Ministry of Economy, Trade and Industory

80

85

90

95

100

105

110

115

120

125

2010

2011

2012

2013

2014

2015

2016

Inventory/Shipment ratio (2010=100)

Note: red line is quarterly numbers.(Source) Ministry of Economy, Trade and Industory

6

Machinery orders indicate continuing appetite for CAPEX, especially from non-manufacturing side

Capital investments, especially from non-manufacturing industries show strength and also manufacturing

industries show some resilience when interpreted by recent machinery orders statistics.

Government has set nominal GDP target of yen 600 trillion in FY2021. Productivity improvement in the service

sector is expected to play a key roll with an ambitious target of 2% per annum improvement.

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 1 2 3

12 13 14 15 16

(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 orders from shipping & electric power.

Non-manufacturing

Manufacturing

7

Consumers’ sentiment should be supported by real income growth and job security

Despite recent weakness in consumer spending, fundamentals surrounding households are still solid.

Tight labor market should provide job security and aggregated real wage continues to grow where all three

factors, nominal wage, number of employees and low inflation contributed in March.

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

2012 2013 2014 2015 2016

Job vacancies/ seekers ratio (times)

(Source) Ministry of Health, Labor and welfare

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

2012 2013 2014 2015 2016

Nominal wage

Number of employees

Inflation

Aggregated employees real income

(Source) Ministry of Health, Labor and Welfare

(%)

Aggregated employees' real income and contribution by components (YoY%)

8

Core CPI fell in negative YoY change in March

Core CPI fell -0.3% YoY in March. It is expected to stay negative for about a year.

Inflation expectation is falling and CPI watched by BOJ is also declining for the last 3 months. SMAM expect

BOJ to make additional easing in June or in July together with the fiscal stimulus measures from the

government.

-0.30

-0.99

0.44

1.0

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

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

2013 2014 2015 2016 2017

CPI and contribution by main components(YoY %)

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

Forecast by SMAM

Core CPI(excl. fresh food)

Food(excl. fresh food)

Energy

CPI watched by BOJ(excl. fresh food & energy)

Note: Excluding direct impact from consumption tax hike in April 2014.

Outlook for Japanese Stock Markets

9

Stock market outlook: waiting for fiscal stimulus measures and global economic recovery

SMAM short-term view Negative news on corporate earnings has been completed. There are many events waiting ahead such as next

US interest rate hike, possible monetary & fiscal stimulus in Japan, Upper House election in July. High volatility is expected to stay, however, expectation for further stimulus could lift the stock market for the short term.

Longer-term outlook (6-months and beyond) Sluggish Chinese economy is likely to continue. US economy shows some strength, however, it makes FED

rate hike more possible. Overseas economy is going to stay patchy. The key for the Japanese economy and stock market will be a)what kind and amount of stimulus measures are

taken and b)how effective they turn out.

Note: SMAM’s projection is as of May 20th 2016 and subject to updates without notice

10

700

900

1,100

1,300

1,500

1,700

1,900

Ja

n-1

3

Fe

b-1

3M

ar-

13

Ap

r-1

3

Ma

y-1

3

Ju

n-1

3

Ju

l-1

3

Au

g-1

3

Se

p-1

3

Oct-

13

No

v-1

3

De

c-1

3

Ja

n-1

4

Fe

b-1

4M

ar-

14

Ap

r-1

4

Ma

y-1

4

Ju

n-1

4

Ju

l-1

4

Au

g-1

4

Se

p-1

4

Oct-

14

No

v-1

4

De

c-1

4

Ja

n-1

5

Fe

b-1

5M

ar-

15

Ap

r-1

5

Ma

y-1

5

Ju

n-1

5

Ju

l-1

5

Au

g-1

5

Se

p-1

5

Oct-

15

No

v-1

5

De

c-1

5

Ja

n-1

6

Fe

b-1

6M

ar-

16

Ap

r-1

6

Ma

y-1

6

Ju

n-1

6

Ju

l-1

6

Au

g-1

6

Se

p-1

6

Oct-

16

No

v-1

6

De

c-1

6

Ja

n-1

7

Fe

b-1

7M

ar-

17

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 growth to gradually recover from the negative shock of higher 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 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

Earnings announcement for FY 2015 has almost finished. According to Mitsubishi UFJ Morgan Stanley

Securities, YoY recurring profits growth was +2.1% and shareholder earnings growth was -2.2% for all

companies listed on Tokyo Stock Exchange 1st section and ending fiscal year in March. For FY2016,

companies forecast +0.3% recurring profit growth and +10.6% shareholder earnings growth.

Majority of the Japanese companies set 110 yen/dollar rate as a proposition for the earnings forecast

for FY2016, which is about the middle of SMAM’s current forecast range for yen/dollar, between 102

and 115 for FY2016.

If yen stabilizes around the current level, further negative currency impact can be avoided, and

conservative earnings estimates by companies can be gradually revised upward.

Strong yen and sluggish overseas demand has been negative for the corporate earnings in FY2015

89

104

16.9%

0%

10%

20%

30%

40%

50%

60%

70%

0

20

40

60

80

100

120

11/04 12/04 13/04 14/04 15/04 16/04

IBES EPS consensus forecast for TOPIX

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

Up to May 18th, 2016(Source) Datastream, IBES

(Points)

-40%

-30%

-20%

-10%

+0%

+10%

+20%

+30%

2011 2012 2013 2014 2015 2016

TOPIX Earnings Forecast Revision Index

Notes: Revision index= % of Analyst upgrades out of total Topix firms - % of downgrades. Calender year, weeklySource: IBES, SMAM Up to May 18th 2016

13

Despite declining earnings growth for FY2015, many companies have announced large share buy-back

programs for FY2016, which is an encouraging sign that they keep positive attitude for enhancing

shareholder returns.

Total shareholder return ratio is expected to rise to 46.4% in FY2015 and forecast to rise further to

49.1% in FY2016 in just 4 years from the latest trough of 32.6% recorded in FY2013.

Japanese companies continue large share buy-back programs

E F

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

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

and 16x except for temporary overshooting.

Even considering further down-revision in earnings, current TOPIX level doesn't look expensive.

14

300

500

700

900

1,100

1,300

1,500

1,700

1,900

Jan-0

7M

ar-

07

Ma

y-0

7Jul-0

7S

ep-0

7N

ov-0

7Jan-0

8M

ar-

08

Ma

y-0

8Jul-0

8S

ep-0

8N

ov-0

8Jan-0

9M

ar-

09

Ma

y-0

9Jul-0

9S

ep-0

9N

ov-0

9Jan-1

0M

ar-

10

Ma

y-1

0Jul-1

0S

ep-1

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0Jan-1

1M

ar-

11

Ma

y-1

1Jul-1

1S

ep-1

1N

ov-1

1Jan-1

2M

ar-

12

Ma

y-1

2Jul-1

2S

ep-1

2N

ov-1

2Jan-1

3M

ar-

13

Ma

y-1

3Jul-1

3S

ep-1

3N

ov-1

3Jan-1

4M

ar-

14

Ma

y-1

4Jul-1

4S

ep-1

4N

ov-1

4Jan-1

5M

ar-

15

Ma

y-1

5Jul-1

5S

ep-1

5N

ov-1

5Jan-1

6M

ar-

16

Ma

y-1

6

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 May 13th 2016 when TOPIX was 1320.19

TOPIX and PER based on 12-month forward EPS

16x

12x

13x

14x

15xPM Abe's 2nd term started

Abe cabinet has so far survived challenging issues such as earthquake and foreign affairs

Approval rating of Abe cabinet improved to 45% in May surviving challenging issues such as management of

Kumamoto earthquake disaster and various diplomatic issues, which are US president Obama’s planned visit to

Hiroshima and other top level negotiations preparing for the G7 meeting in Japan.

Declaring coordinated fiscal stimulus at G7, which PM Abe has been targeting, is not likely to be made, however,

large fiscal spending plan can be expected from Japanese government.

15

0

10

20

30

40

50

60

70

80

90

Au

g-9

8

Fe

b-9

9

Au

g-9

9

Fe

b-0

0

Au

g-0

0

Fe

b-0

1

Au

g-0

1

Fe

b-0

2

Au

g-0

2

Fe

b-0

3

Au

g-0

3

Fe

b-0

4

Au

g-0

4

Fe

b-0

5

Aug-0

5

Fe

b-0

6

Au

g-0

6

Fe

b-0

7

Au

g-0

7

Fe

b-0

8

Au

g-0

8

Fe

b-0

9

Au

g-0

9

Fe

b-1

0

Au

g-1

0

Fe

b-1

1

Au

g-1

1

Fe

b-1

2

Au

g-1

2

Fe

b-1

3

Au

g-1

3

Fe

b-1

4

Au

g-1

4

Fe

b-1

5

Aug-1

5

Fe

b-1

6

Obuchi

Mori

Koizumi

Abe 1

Fukuda

Aso

Hatoyama

Kan

Noda

Abe 2

Approval ratings of Japanese cabinets by Prime Ministers(%)

(Source) NHK

May 45%

Aug. 37%

Current Abe

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

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 exchangeData for May 2016 is from May 2nd to May 13th. Up to May 13th 2016

2016

Selling pressure from overseas subsided

Selling by foreign investors peaked out in March.

Business corporations are expected to be a constant buyer going forward due to a record making share buy-

back programs announced by companies.

16

17

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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.

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