Asia's New Stock-Market King Has Strong Profits, BOJ Support

(Bloomberg) -- With Japan regaining its place as the second-biggest stock market amid growing trade tensions between the world's two largest economies, investors expect the nation's equities to garner more attention.

Japanese shares were worth $6.15 trillion on Friday compared with just under $6 trillion for Chinese equities, according to data compiled by Bloomberg. The markets swapped position behind the U.S. for the first time since 2014, making Japan Asia's biggest stock market.

While Chinese stocks have suffered recently from the country's ongoing trade spat with the U.S., their Japanese peers have benefited from improved earnings and the Bank of Japan's annual purchase of up to 6 trillion yen ($54 billion) in exchange-traded funds. Still, market observers are divided over what impact the mounting trade war might have on Japan.

“If China and the U.S. are going to throw bricks at each other's windows, it pays to be the one that sells glass to both sides,” said Nicholas Smith, an equity strategist at CLSA Ltd. “That's Japan.”

The Topix index has lost 4.1 percent this year, compared with a 17 percent slide in the Shanghai Composite Index.

Nearly 60 percent of companies listed on the Japanese benchmark that have reported earnings so far for the latest quarter have beaten analyst expectations. Notable companies announcing results this week include SoftBank Group Corp., Nippon Telegraph & Telephone Corp. and Recruit Holdings Co.

Big Beats

“We've seen some pretty big beats from some big companies including Sony, Hitachi and Fujitsu. That's the major driver,” said Kieran Calder, head of Asia equity research at Union Bancaire Privee.

He expects the positive trend in Japanese earnings to continue. First-quarter results suggest room for upward revisions of company guidance, which tend to be conservative at the start of the fiscal year, he said. With many firms basing their forecasts on the yen at 105 per dollar, the current level serves as a tailwind for those sensitive to currency movements, Calder added.

Japan regaining the No. 2 spot calls attention to its “market thrashing consensus earnings forecasts” as well as its relatively appealing valuations, CLSA's Smith said.

External Economies

Japan remains dependent on external economies such as China and U.S. as well as on a weaker yen, said Yoshinori Shigemi, global market strategist at JPMorgan Asset Management. Corporate earnings should remain solid “as long as we see a continuing strong expansion in the U.S. economy, and action by China to support their economy by increasing fiscal spending and easing monetary policy.”

Corporate Governance Enthusiasm

“There is a newfound enthusiasm for corporate governance that is manifesting with announced share buybacks year-to-date being up in value terms by over 25 percent year-on-year,” said CLSA's Smith. In Japan 58 percent of Topix non-financials are net cash, and “at last shareholders are starting to unlock some of that hitherto trapped value.”

Political stability, an attractive valuation compared with other developed markets and signs of improving corporate governance are fueling Nomura's optimism on Japan's equity market, said Nomura Holdings Inc. strategist Jim McCafferty. The firm is overweight on the shares.

The 2014 publication of the stewardship code aiming at encouraging investors to be more forceful in demanding higher returns will lead to companies putting more money to work. As a result, they'll either expand their business or increase dividends or share buybacks, McCafferty said.

Staying Neutral

“We haven't changed our Japanese exposure in the last few months, maintaining a neutral exposure,” said Daryl Liew, head of portfolio management at Reyl Singapore Pte. There have been “no real red flags” after “decent” earnings results so far.

“Japan being No. 1 or No. 2 doesn't effect us at all as we are all about market and sector depth, as well as cheap transparent trading costs, which is something Japan offers well ahead of China,” said Andrew Jackson, head of Japanese equities at Soochow CSSD Capital Markets. “It's more about volatility for me than anything.”

Re-discovering Japan

“The news will make global investors pay more attention to Japan and that will result in re-discovering the attractions of Japanese companies,” said Hideaki Fukuchi, Asia equity sales at Auerbach Grayson and Co. in New York.

Retaking the No. 2 position was due to not only the better prospects of the Japanese economy but also Japanese companies' long-term efforts to pursue more advanced technologies, improve corporate efficiency and focus on better corporate governance, Fukuchi said.

--With assistance from Michael Patterson.

To contact the reporters on this story: Abhishek Vishnoi in Singapore at avishnoi4@bloomberg.net;Moxy Ying in Hong Kong at yying13@bloomberg.net;Livia Yap in Singapore at lyap14@bloomberg.net

To contact the editors responsible for this story: Divya Balji at dbalji1@bloomberg.net, Kurt Schussler, Cecile Vannucci