For the first 11 months of this year, the Nikkei 225 has risen nearly 7% and has been pushing new seven-year highs.
Investor sentiment has been lifted by the latest earnings season. Japanese companies posted some of their highest profits ever and the weakening yen is boosting exporters from automakers to retailers.
Based on Bloomberg estimates, aggregate net income at 195 of the largest listed companies will grow 10% to a record of 17.5 trillion yen this fiscal year.
There are a range of factors set to lift Japanese stocks next year. These include fresh stimulus measures resulting in a weaker yen, upcoming elections boosting market euphoria, and an increase of investment focus in domestic stocks by the country’s pension fund.
A core part of Prime Minister Shinzo Abe’s economic policies is to generate inflation by depreciating the yen, this has led to exporters emerging as one of the biggest beneficiaries. Hence a weaker Japanese currency typically translates as support for local equities and suggests a brighter earnings outlook.
Besides making exports more competitively priced, revenue translated from foreign currencies back to yen will also be boosted.
In the first 11 months, the yen weakened over 12% against the greenback and it is set to continue drifting lower.
The currency has come under renewed pressure since the Bank of Japan (BoJ) surprised markets by rolling out a second round of quantitative and qualitative easing in October. This involved expanding government debt purchases to 80 trillion yen (US$676 billion), from 60 to70 trillion yen annually, in a bid to bolster its chances of hitting its inflation target of 2%. On the news, the outlook for a drastically weakened yen prompted a 4% jump by the Nikkei 225.
With core inflation still not getting much traction, the BoJ has been reiterating its commitment to generate 2% inflation. If macroeconomic indicators continue to remain unconvincing, more stimulus measures will likely be on the cards.
Pension fund’s investments
The second blast of the bazooka that shook markets came in just hours after the news of Japan’s second round of quantitative and qualitative easing.
Japan’s US$1.2 trillion public retirement savings fund will embark on a new investment strategy to enhance returns. It will be rejigging its portfolio to include a heavier allocation to domestic and overseas equities and less on bonds.
This will see the Government Pension Investment Fund (GPIF) increase its holdings of Japanese shares to 25 percent. This means it is likely to buy nearly US$86 billion worth of domestic stocks to meet the target, based on holdings in June, according to Bloomberg data. This flood of money is likely to go some way in propping up the Nikkei 225 over the next year.
Less than two years into his term, Abe has called for a fresh election on Sunday 14 December to seek a fresh mandate for his policies. His announcement came a day after Japan slid into recession for the third time in four years, raising questions over the effectiveness of his economic reforms.
Japanese stocks typically gain after elections are called, based on data provided by Bloomberg and Daiwa Securities Group. In 11 elections over the past 25 years, the Topix index has posted a 3.1% average total return between the dissolution of parliament and the vote.
Along with the plans for the snap election, Abe also announced he would delay the second sales tax hike to 10%, by 18 months, this was initially scheduled for October 2015. The postponement is likely to boost the economy in the near term, as it will spare household incomes from further pressure.
So far, we have seen retail stocks advancing ahead of an expected pickup in consumer spending. As inflationary pressures prop up asset prices, other winners are also likely to include real estate and financial firms.
Some companies though may face more headwinds, particularly those with foreign input costs and local demand. For example, McDonald’s Japan, which depends on imported ingredients, has warned a weaker yen will hurt its bottom line. It estimated profits to reduce by about 100 million yen every time the exchange rate drops by one yen against the greenback.