(Bloomberg) -- A stellar rally for smaller-sized Japanese companies over the last two years is about to face its biggest test yet should evidence emerge this earnings season that the country’s tight labor market is starting to erode profitability.
A combination of attractive relative valuations for larger stocks and the greater hit to small and medium enterprises from labor shortages should boost investor interest in big caps, according to strategists at Mitsubishi UFJ Morgan Stanley.
“Wages are rising gradually as employment improves, meaning personnel costs will likely weigh on earnings for SMEs, who are struggling to recruit the necessary staff,” Chisato Haganuma and Kazuya Nakagawa wrote in a recent report. “We note the possibility of large caps gaining an edge based on corporate results.”
The Topix Small Index has risen about 42 percent over the last two years, compared to a 26 percent gain in the Topix 500 Index. Japan’s labor cash earnings jumped 1.3 percent in February from a year earlier, the highest since 2016, as the country’s unemployment rate fell to 2.5 percent.
The gap between earnings at smaller and larger firms will depend on each company’s capacity to pass on higher costs to customers, the strategists wrote. That, currently, favors larger stocks, they said.
“Investors are currently poised to raise their weighting on large caps.”
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