Japan Stocks Lag Behind in Asia With Abe Risk Casting Cloud

(Bloomberg) -- After handily beating the rest of Asia for much of the past five years, Japanese stocks are lagging behind in 2017, with strategists now worrying about the outside chance of the author of Abenomics stepping down.

“If Abe quits, investors will be really done with Japanese equities,” said Naoki Iizuka at Citigroup Inc., representing the bearish extreme when it comes to concerns about Prime Minister Shinzo Abe’s deteriorating political position. “Abenomics was about fighting back pessimism over deflationary Japan. It’ll be dangerous without it.”

For now, Iizuka is keeping his "overweight" call for Japan’s stocks given valuation levels relative to earnings that compare favorably with other markets, and still-solid earnings growth. But a number of strategists, including at Goldman Sachs Group Inc., have tempered their enthusiasm in recent weeks as key drivers for gains have faded:

  • The record amounts of stock buybacks and dividend increases, propelled by Abe’s corporate-governance reforms, have now subsided .
  • While the Bank of Japan is unlikely to tighten monetary policy before Abe’s handpicked governor, Haruhiko Kuroda, departs in April, no new stimulus is projected by economists.
  • Corporate profits slipped from record levels this year, with gains in the yen this year weighing on earnings. The latest quarterly results are now being released, with the schedule kicking into high gear this week.
Japan Stocks Lag Behind in Asia With Abe Risk Casting Cloud

Abe’s position poses the biggest danger for the market, after his election victory on a platform of massive monetary stimulus and structural reforms for Japan’s long-stagnant economy started juicing Japan’s stock market from late 2012.

Foreign investors have been disappointed with reforms and are now more skeptical about Abe’s ability to push economic policies that lift corporate profitability, Daniel Morris, a senior investment strategist at BNP Paribas Asset Management, said in an interview in Singapore. He said Japan has always been a “very low profitability market” in his view, and is keeping an underweight stance on the country.

A series of scandals has hit Abe’s cabinet this year, and his push to loosen the constitution’s restrictions on Japan’s armed forces has proved divisive, contributing to a slump in his poll ratings. The shift has raised questions whether Abe could stay on as head of the ruling party, after a long period when most anticipated him winning a third term starting September 2018.

“The scenario had been for Abe to be reelected next September but that’s been shaken up -- whether his policies will be sustained will be in question, and the market can’t help but reflect those risks,” said Makoto Yamaguchi, general manager for Bayview Asset Management Co. in Tokyo, who himself is still positive on Japanese equities. “Everything has been under the premise of Abenomics.”

Even so, some analysts see little fundamental change in Japan’s policies even if Abe were to leave the scene, with few signs that potential successors are keen advocates of reining in the Bank of Japan’s mega-stimulus program. Some have also speculated that Abe could embrace greater fiscal spending to shore up his position, something that could boost economic growth.

The Topix’s relative valuation could also be a lure.

Japan Stocks Lag Behind in Asia With Abe Risk Casting Cloud

Japan’s stocks have other hurdles, however. The market has a relatively small proportion of technology stocks, reducing its attraction relative to others amid a global boom in the sector. Citigroup estimates information-technology stocks held a 12 percent weighting in the Japanese market as of mid-July, compared with 23 percent for the U.S. and 25 percent for the rest of Asia.

Goldman Sachs Group Inc. recently cut its near-term forecast for the Topix, citing a number of risks including political uncertainty -- a dynamic that hasn’t been present in Japan since a series of short-lived prime ministerships ended in 2012 with Abe’s win.

“Where do we have strong government today?” said Bryan Goh, Singapore-based chief investment officer for Bordier & Cie. “We have India and we have Japan. And you can see that it has paid off for these countries. But then if that gets threatens then, you might have to worry a little bit.”