Japanese Stock Market Outlook

SMAM monthly comments & views - January 2017 -

Japanese Economy

SMAM revised GDP growth forecast for FY2016 from +0.9% to +1.2% and for FY2017 from +0.9% to +1.1% due mainly to change in GDP measurement standard, in which Research & Development spending is counted as capital investment, a part of GDP. By the new measurement standard, Real GDP growth has shifted upward by 0.5% on average for the immediate past 3 years from 2013 to 2015. Nominal GDP in 2015 was substantially revised up to 532 trillion yen surpassing previous high of 531 trillion yen recorded in 2007.

• SMAM forecasts US$/yen range between 112 and 122 for 2017 with a risk for the downside to 105 if US moves to cap and

reverse the dollar strength considering its negative effects on US industries.

• According to the latest BOJ Tankan Business Survey, recovering global economy has positively impacted exports and

production in Japan leading to the improvement in business sentiments both for manufacturing and non-manufacturing

industries.

Japanese Stock Markets

After a Trump honeymoon rally lifting Japanese stocks market-wide in late 2016, focus is going to such factors as (a)strong earnings growth expected in Jan-Mar quarter and onwards, and (b)how Trump policies actually develop both on domestic and international fronts. Current PER over 15x seems a little stretched and the stock market would require some breathing period for the expected earnings growth to be actually achieved.

• Japanese equities will be supported by improving fundamentals in the long-term. Double digit earnings growth is expected

for FY2017. Further fiscal stimulus can be expected in Japan meanwhile BOJ would keep its extra-easy monetary policy. As

a main scenario, Trump’s trade policy is expected to focus on bilateral negotiations to open other countries’ markets and

would not be so protectionist as feared.

• After falling for 2 consecutive years in FY2014 and 15, ROE is forecast to recover to 9.2% in FY2016 and to reach 10%

mark in FY2017. ( for SMAM 221 companies excluding financials)

Executive summary

1 Notes: Macro and market views are as of Dec.15th and 19th , 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

SMAM revised GDP growth forecast for FY2016 from +0.9% to +1.2% and for FY2017 from +0.9% to +1.1%

due mainly to change in GDP measurement standard, in which Research & Development spending is counted

as capital investment, a part of GDP.

Forecast for FY2018 was released predicting moderate growth to continue despite plateauing contribution from

the public sector.

Notes: E=SMAM forecasts. SMAM views are as of Dec 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 FY16-18

( YoY %)

Real GDP growth 2.6% -0.4% 1.3% 1.2% 1.1% 0.9%

Private Consumption Expenditure 2.7% -2.7% 0.5% 0.7% 0.6% 0.6%

Private Housing Investment 8.3% -9.9% 2.7% 5.7% -0.0% 1.0%

Private Capital Investment 7.0% 2.5% 0.6% 1.4% 1.5% 2.1%

Public Consumption Expenditure 1.7% 0.4% 2.0% 0.7% 1.1% 0.9%

Public Capital Investment 8.6% -2.1% -2.0% 0.1% 5.7% 0.2%

Net Exports (contrib. to GDP growth) -0.5% 0.6% 0.2% 0.4% 0.2% 0.1%

Exports 4.4% 8.7% 0.8% 1.1% 2.4% 1.7%

Imports 7.1% 4.1% -0.2% -1.5% 1.2% 1.0%

Nominal GDP 2.6% 2.1% 2.8% 1.3% 1.6% 1.6%

GDP Deflator 0.0% 2.5% 1.4% 0.0% 0.6% 0.7%

Industrial Production 3.0% -0.4% -1.4% 0.9% 3.3% 2.5%

CPI (excl. fresh food) 0.8% 0.9% -0.0% -0.3% 0.7% 0.7%

FY16E FY18EFY13 FY14 FY15 FY17E

4

GDP measurement standard has changed making substantially positive impact

GDP measurement standard has changed this time making clearly positive impact. The biggest change is

counting Research & Development spending as capital investment, a part of GDP.

For the immediate past 3 years from 2013 to 2015, Real GDP growth has shifted upward by 0.5% on average.

By the new measurement standard, Nominal GDP in 2015 was 532 trillion yen surpassing previous high of 531

trillion yen recorded in 2007.

(Source) Cabinet Office, compiled by SMAM

Real GDP YOY Growth (%)

2.6

-0.4

1.3

2.0

-0.9

0.9

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

New measurement(08SNA)

Old measurement(93SNA)

(Year) (Year) (Source) Cabinet Office, compiled by SMAM

Nominal GDP (Trillion yen)

531.0 532.2

513.0

500.6

450

460

470

480

490

500

510

520

530

540

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

千

New measurement(08SNA)

Old measurement(93SNA)

Widening Interest rate gap is one of the factors behind the strong US$ against Japanese yen

Steepening of yield curve continues for US and Europe whereas still kept low in Japan.

FRB in the US decided to hike its policy rate by 0.25% in December FOMC meeting.

Widening interest rate gap is one of the reasons why dollar is moving stronger against Japanese yen.

SMAM forecasts US$/yen range between 112 and 122 for 2017 with a risk for the downside to 105 if US moves

to cap and reverse the dollar strength considering its negative effects on US industries.

5

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 Dec. 16th, 2016

(Source) Datastream

(Month/Year)

70

80

90

100

110

120

130

140

▲ 5

▲ 4

▲ 3

▲ 2

▲ 1

0

1

2

3

00 02 04 06 08 10 12 14 16

2YGB US-JP yeild gap(left)

US$/JPY(right)

US$/JPY and US-JP 2Y real yield gap

Note: Real yield "JGB2Y yield - Japan CPI excl. fresh food & energy" for Japan, and "US2Ytreasury yield - US core CPI" for US. Data is up to Dec. 19th 2016.(Source) Bloomberg

(Year)

(%) (yen)

6

CPI forecast was revised upward

Due to underlying firm consumer prices and higher oil & commodity prices, SMAM revised CPI forecast upward.

Now, CPI is forecast to move up to positive territory during 1Q of 2017, which was previously forecast to be in

the middle of 2017.

CPI is forecast to reach +0.9% by the end of 2017 and BOJ is going to refrain from making additional easing

moves in 2017 despite it is still lower than 2% target set by BOJ.

-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 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

2014 2015 2016 2017 2018

Food (excl. fresh food)

Energy

Baseline CPI (excl. food & energy)

Core CPI (excl. fresh food)

Nationwide CPI and contribution of components(YoY %)

(Source) Ministry of Internal Affairs & Communications

Forecast by SMAM

Note: Effect of consumption tax hike in April 2014 is excluded.(Month/Year)

Business sentiment has been noticeably improving

According to the latest BOJ Tankan Business Survey, recovering global economy has positively impacted

exports and production in Japan leading to the improvement in business sentiments both for manufacturing and

non-manufacturing industries.

DI above zero means more respondents are feeling business conditions getting better than getting worse.

7

(Source) Bank of Japan

BOJ Tankan Business Survey, manufacturing enterprises(all size)

-60

-50

-40

-30

-20

-10

0

10

20

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Current condition DI

Future condition DI

4Q 2016

1Q 2017

(Source) Bank of Japan

BOJ Tankan Business Survey, Non-manufacturing enterprises(all size)

-70

-60

-50

-40

-30

-20

-10

0

10

20

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Current condition DI

Future condition DI

4Q 2016

1Q 2017

(Year) (Year)

Political events should gather attention in 2017

The most important event should be the inauguration of Mr. Donald Trump as the US president on January 20th.

How Trump policies are actually implemented both on domestic side and international trade side can affect

global economy and financial markets.

Europe is going to face important events such as notification of Brexit and elections in France.

Japan has an advantage of stable politics, and PM Abe has a precious opportunity to impress the world by

pushing social reform and growth enhancing strategies forwards.

8

Schedule of key events in the first half of 2017Month Region/Country Events Notes

Ordinary Session of National Diet begins

BOJ perspective report

USA (20th) Donald Trump becomes US president

February Japan First estimate of 4Q 2016 GDP

Convention of the Liberal Democratic Party Extend maximum party leadership from 2 terms running?

Spring wage negotiations

Budget for FY2017 to be approved

Action plan for changing working practice

Netherlands General election

UK Notification of exiting EU?

BOJ Tankan business report

BOJ perspective report

Apr or May France Presidential election

Japan Ordinary Session of National Diet ends

Japan Election for the Tokyo Metropolitan Assembly

France Lower house election

(Source) Various publications, assembled by SMAM

January

March

April

June

Japan

Japan

Japan

Outlook for Japanese Stock Markets

9

Stock market outlook: What could happen after Donald Trump becomes US president ?

SMAM short-term view After a Trump honeymoon rally lifting Japanese stocks market-wide in late 2016, focus is going to such factors

as (a)strong earnings growth expected in Jan-Mar quarter and onwards, and (b)how Trump policies actually develop both on domestic and international fronts. Current PER over 15x seems a little stretched and the stock market would require some breathing period for the expected earnings growth to be actually achieved.

Longer-term outlook (6-months and beyond) Japanese equities will be supported by improving fundamentals in the long-term. Double digit earnings growth

is expected for FY2017. Further fiscal stimulus can be expected in Japan meanwhile BOJ would keep its extra-easy monetary policy. As a main scenario, Trump’s trade policy is expected to focus on bilateral negotiations to open other countries’ markets and would not be so protectionist as feared.

Note: SMAM’s projection is as of Dec. 19th,, 2016 and subject to updates without notice

10

700

900

1,100

1,300

1,500

1,700

1,900

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

Jan-1

7

Feb

-17

Ma

r-1

7

Apr-

17

Ma

y-1

7

Jun-1

7

Jul-1

7

Aug-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 keeps on its growth path.

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

• Japanese yen does not get extremely stronger beyond 100 yen against US$.

• 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 December 2016

12

Share prices rose to more than offset currency weakness for Europe and Japan in December

12

US stocks continues rallying. Yen based Japanese stock prices also rallied substantially, however, it has not

enough to catch up with yen’s weakening against US$ since US presidential election in November.

Emerging equity markets are having difficult times from stronger US$.

707580859095

100105110115120 MSCI

EM/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. Dec. 2016 data is as of 19th.

(Month/Year)

13

At the announcement of 2Q results, companies were implicitly forecasting +10.7% profit growth for the

following 6 months between Sep 2016 and Mar 2017.

Yen has substantially depreciated since then and global economy has picked up. SMAM now forecasts

YOY recurring profit growth of 21.8% for the latter half of FY2016 and 11.3% for entire FY2017.

(Note: *Numbers are for 221 companies in SMAM research coverage excluding financials.)

SMAM forecast 21.8% YOY profit increase for Sep 2016-Mar 2017 period

(Source) Toyo Keizai, announcement of each company, compiled by SMAM

Recurring profits forecast by companies as of the end of 2Q 2016

SMAM research coverage of 221 companies excluding financials

FY2015 (from Apr2015 to Mar2016) FY2016 (from Apr2016 to Mar2017) FY2016 FY2017

(yen bil. %)FY2015

total

FY2016

total

1Q(Apr-

Jun)2Q 3Q 4Q

1Q(Apr-

Jun)2Q 3Q 4Q

Recurring

profits9,066 8,264 7,695 4,348 29,365 7,541 7,697 - - 28,571 29,907 33,841

YoY% 28.60% 0.40% 1.10% -26.50% 2.50% -16.80% -6.86% - - -2.71% 1.84% 11.30%

3Q to 4Q tot. 14,669 -

YoY% 21.8% -

US$/yen

Month end

average

(actual)

121.9 121.7 121.2 115.4 120.1 106.8 102.3 112.37* ? ? 107.2** 110**

*As of Dec20th**Assumption for

SMAM forecast

SMAM forecast as of

Dec. 5th 2016

12,043

-11.0%

13,333

10.7%

Yen appreciated by 19%

14

SMAM forecasts consecutive years of profit growth since FY2013 can be maintained for FY2016 and

17. For FY 2016, profit of Non-manufacturing sector is forecast to grow by 9.3% to offset the decline in

Manufacturing sector of -4.1%.

After falling for 2 consecutive years in FY2014 and 15, ROE is forecast to recover to 9.2% in FY2016

and to reach 10% mark in FY2017.

(Note: *Numbers are for 221 companies in SMAM research coverage excluding financials.)

ROE is on a recovering path to 10% mark expected in 2017

27,547

29,073

29,357 33,107

17,996

17,251

20,105

11,07712,107

13,002

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

200

2/A

200

3/A

200

4/A

200

5/A

200

6/A

200

7/A

200

8/A

200

9/A

201

0/A

201

1/A

201

2/A

201

3/A

201

4/A

201

5/A

201

6/E

201

7/E

(yen bil.)

SMAM 221 companies recurring profits (excl. financials)

Total industries

Manufacturing

Non-manufacturing

(Source) announcement by companies, forecast by SMAM.(Fiscal year)

10.9%

1.7%

4.5%

6.8%

5.0%

6.2%

9.5%

8.9%

8.2%

9.2%

10.0%

0%

2%

4%

6%

8%

10%

12%

200

1A

200

2A

200

3A

200

4A

200

5A

200

6A

200

7A

200

8A

200

9A

201

0A

201

1A

201

2A

201

3A

201

4A

201

5A

201

6E

201

7E

SMAM 221 companies ROE (excl. financials)

Forecast

(Source) announcement by companies, forecast by SMAM.

(Fiscal year)Note: Data label is for the all industries.

PER (Price Earnings Ratio) seems stretched over 15x

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 December 16th, PER for TOPIX was 15.18x based on 12M forward EPS and 14.5x using higher 18M

forward EPS. Stock prices might need breathing space to wait for the estimated earnings growth to be actually

achieved and earnings forecast to be lifted further.

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

Jun-0

8A

ug-0

8O

ct-

08

De

c-0

8F

eb

-09

Apr-

09

Jun-0

9A

ug-0

9O

ct-

09

De

c-0

9F

eb

-10

Apr-

10

Jun-1

0A

ug-1

0O

ct-

10

De

c-1

0F

eb

-11

Apr-

11

Jun-1

1A

ug-1

1O

ct-

11

De

c-1

1F

eb

-12

Apr-

12

Jun-1

2A

ug-1

2O

ct-

12

De

c-1

2F

eb

-13

Apr-

13

Jun-1

3A

ug-1

3O

ct-

13

De

c-1

3F

eb

-14

Apr-

14

Jun-1

4A

ug-1

4O

ct-

14

De

c-1

4F

eb

-15

Apr-

15

Jun-1

5A

ug-1

5O

ct-

15

De

c-1

5F

eb

-16

Apr-

16

Jun-1

6A

ug-1

6O

ct-

16

De

c-1

6

Note: Data is weekly from Oct. 26th 2007 to Dec. 16th 2016. TOPIX was 1550.67 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

15x

PM Abe's 2nd term started

Foreign investors purchasing continues to lift stock prices

Foreign investors purchased Japanese stocks by as much as 1.54 trillion yen in November.

Japanese individual investors were selling Japanese stocks as stock prices recovered.

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 Dec

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 Dec.9th 2016.

2016 (Month/Year)

17

Japanese stock market is technically overheated

17

Gainers/Losers ratio is regarded as an indicator for the temperature of stock markets. Over 120% typically

shows the market is overheated. The ratio went up above 160% on 15th December first time since June 2014.

It’s natural to expect for a breathing period for a while, however, in the previous comparable cases in the

beginning of 2013 and in June 2014, the stock prices did not take visible breaks while this ratio gradually

calmed down.

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

40

60

80

100

120

140

160

180

200

220

240

260

280

300

Gainers/Losers ratio(left axis) and TOPIX(right axis)

Notes Gainers/Losers ratio = No. of stocks with rising share price / No. of stocks with falling share price (%)Source: Tokyo Stock Exchange, SMAM

(Year/Month)

Up to Dec. 16th 2016

(%)

Points

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.

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

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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

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