The Japanese economy continues to recover; the companies‘ earnings situation is solid.
» Companies are making structural progress on corporate governance, financial engineering (including distribution policy) and M&A activities. The equity market is also considered attractive.
» The Topix is expected to rise to 1,850 points by the end of the year. Even so, this forecast does not suggest it will outperform other markets. The greatest risk is an escalation of a trade war between the US and China.
The Japanese economy continues to recover. This is apparent, among other things, from the labour market, where unemployment recently dipped below 2.5%.
Thanks to good domestic economic performance and stable foreign demand, earnings development on the Japanese equity market should remain very solid. We expect corporate profits in the Topix to rise by more than eight percent year-on-year, with seven percent growth predicted for the following year. Intensification of the trade conflict between the US and China poses a risk to earnings development. Because of its geographical “sandwich” position, Japan would probably be affected more than other export heavyweights, such as Germany. We can imagine two negative operating mechanisms here: on the one hand, the yen could appreciate as a safe haven, which would have negative repercussions for the competitive situation of Japanese companies on foreign markets. On the other hand, weaker Chinese and US economies would translate directly into weakened demand for Japanese products. This would impact on the Japanese sectors to varying degrees; the technology sector would probably suffer more than average in the short term. Example: rising prices brought about by customs and economic uncertainty would have an immediate negative effect on the supply chains of smart phones and related products, even though structural demand in this segment remains positive. Companies from other sectors that operate a disproportionately high volume of business in China could also suffer losses in this (secondary) scenario of an intensifying trade war.
The above-average correction compared with other international equity indices – the Topix has eased by almost 14% since January – depressed the valuation of the Topix, despite rising prices again in the last few weeks. An estimated price-earnings ratio of 13.4 is currently registered for 2019, compared with an average of 14.7 for the last 15 years. The theoretical undervaluation is therefore around nine percent.
Outlook: Thanks to ample economic optimisation, and corporate governance reforms (key words: family clans, conglomerates) and further opening up of the financial markets (including higher coverage level by financial analysts and publication of English corporate reports), we have seen a sustained improvement in the profitability – measured by parameters such as return-on-equity or profit margins – as well as the image of Japanese companies. Japanese companies are increasingly returning their surplus capital – which is still above average by international standards – to shareholders in the form of dividends and share buybacks or are using it for mergers and acquisitions. The conglomerates are also buying undervalued subsidiaries (e.g. PanaHome by Panasonic). Looking back at previous decades, this is not a matter of course for Japanese companies. Not only are the companies being supported by the very accommodating policy of the Japanese central bank, the equity market is also considered attractive. This also bodes well for the Japanese equity market in the future, so that we assume the Topix will soon continue on its upward trajectory towards our target of 1,850 points by year-end 2018 (plus five percent upside potential). Even so, this forecast does not suggest it will outperform other markets. The greatest risk for the Japanese equity market is that the numerous geopolitical flashpoints will escalate.