High-flying Japanese stocks look to weaker yen after Abe win


As market metaphors go, it was hard to beat the clear blue sky over Tokyo the day after a resounding election victory for Shinzo Abe, Japan’s prime minister.

Seizing on the likelihood of continued monetary and fiscal stimulus, investors pushed the Nikkei 225 higher for a record 15th session to a 21-year high on Monday, while the yen weakened to more than ¥114 per dollar for the first time since early July.

Having weathered a sometimes volatile election campaign, the question for investors is whether Mr Abe’s victory means the Japanese stock market can build on a run that has seen it comfortably outperform European and the US equities since the start of September.

While Mr Abe’s success was not a surprise — the initial challenge posed by Tokyo governor Yuriko Koike’s new political party fizzled — achieving a two-thirds supermajority in parliament will allow him to pursue his priority of constitutional reform and push through a sales tax increase in 2019. Critically, for markets, it means policy continuity at the Bank of Japan.

“The political ‘tail risk’ presented by the snap election has not materialised,” says Yasunori Iwanaga, chief investment officer of Amundi Japan. “Granted the market may pause for breath. But Japanese fundamentals are positive. More companies are upgrading their earnings outlook as business sentiment improves.”

There is little preventing Mr Abe from reappointing Haruhiko Kuroda as BoJ governor when his first term ends next April — or finding a dovish replacement. That will keep the monetary policy spigot wide open, putting downward pressure on the yen and Japanese government bond yields, while providing support for stocks.

The country’s benchmark Topix is now up 14.9 per cent in 2017, almost matching the advance of the S&P 500. A little more than half of the equity market’s gains have come since the end of August, propelling the index to its highest level since July 2007.

As is often the case, a faltering yen has been helping equities. The weakness in the yen from early September when it slid from a 10-month high of ¥107.31 per dollar, has helped stir the most recent leg in the rally. In dollar terms the Topix has gained over 18 per cent so far this year.

Following Mr Abe’s win, Masaki Motomura, an equity strategist at Nomura in Tokyo, has lifted his year-end forecast for the Topix to 1,750 from 1,680, based on an exchange rate of ¥115 to the dollar. He expects the benchmark to be at 1,830 by the end of 2018 versus its level of 1,745.25 on Monday.

“The interest of investors changed from politics to fundamentals in the past three months, so the currency is important for them,” Mr Motomura says. “We forecast the cumulative earnings of major listed companies will increase 5 per cent for every 10 yen move weaker,” he added.

The yen will end the year at ¥113 per dollar by the end of December, according to the median of a Thomson Reuters poll, and ¥114 by the end of September, 2018.

Jesper Koll, head of Japan at WisdomTree, argues Japanese equities deserve a higher price-to-earnings ratio because the pro-growth and pro-business policies that are helping fuel Japan’s domestic investment cycle will be sustained.

However, not everyone is so confident that an emboldened Mr Abe will be kind to the stock market. Barring an economic shock, Mr Abe intends to raise the national sales tax to 10 per cent in October 2019, a move that Marcel Thieliant at Capital Economics warns could push Japan back into recession, as the previous raise to 8 per cent did in 2014.

While Jun Tano, a portfolio manager at Fidelity, cautions that the stock market was already prepared for an Abe victory and that it has been laggard stocks, not the fundamentals of the economy, that have fanned the rally.

“Although this trend may continue in the short term, the valuation gap between laggard stocks and companies with solid earnings is not that significant, particularly compared to the situation last summer,” Mr Tano says. “The trend is therefore unlikely to be sustainable and is not one that I want to chase.”

Appetite from foreign investors will help determine whether stocks can extend their gains. The most recent gains have come despite investors withdrawing $4.4bn from Japan-focused equities funds in the week to October 18 — the largest outflow since at least 2002, according to EPFR Global.

Mr Motomura of Nomura expects foreign investors to be buyers following the election “as they prefer steady political conditions in Japan.”

The rest of the year will provide a test of that assumption.



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