Japan's Small Stocks Are Surging on Haven Demand, Biotech Gains

(Bloomberg) -- In the recent rally in Japanese equities, it has paid to back the gauges of smaller stocks.

The Tokyo Stock Exchange Mothers Index of growing companies has jumped 21 percent from a low on Christmas Day, outpacing a 14 percent advance for the Nikkei 225 Stock Average. The Jasdaq Index, comprised of 712 mostly smaller companies, is also up 21 percent.

Analysts see three reasons for the outperformance. One is smaller companies are often less dependent on exports, and therefore more resilient to external factors such as the trade war and sputtering global economy, according to Tetsuo Seshimo, a fund manager at Saison Asset Management Co. in Tokyo.

“It’s been a good market for the small caps,” Seshimo said. “And given that global economic growth isn’t likely to take off all of a sudden, people will continue to devote attention to individual stocks, particularly the smaller ones.”

Toshiaki Iwasaki, an analyst covering smaller firms at Mito Securities Co. in Tokyo, agreed. “When there’s a strong sense of uncertainty surrounding the global economic outlook, it’s hard to go for the heavyweights,” he said.

The second factor helping smaller shares is dovish monetary policy, which keeps companies’ borrowing costs lower, according to Kiyoshi Ishigane, chief strategist at Mitsubishi UFJ Kokusai Asset Management Co. Japan’s policy rate remains below zero, while the Federal Reserve has recently shifted to a stance that rates could be lower for longer.

“Small and mid-cap companies tend to lose out when interest rates are rising” as it increases borrowing costs for those firms, which tend to invest more aggressively with less capital compared to established groups, Ishigane said.

But the third, and perhaps the most important, reason is that individual stocks have been on fire in the smaller measures. Mothers, for example, has seen 20 companies at least double in the rally. They include biotech firms Sosei Group Corp. and AnGes Inc., which have big weightings in the gauge.

Sosei surged 16 percent in one day last month after its partner Novartis AG launched drug treatments for treating chronic obstructive pulmonary disease in China. AnGes has been helped by winning approval in Japan for a type of gene therapy.

And Mercari Inc., the heaviest-weighted stock in the Mothers measure, is also up 83 percent.

Japan's Small Stocks Are Surging on Haven Demand, Biotech Gains

“Mothers, in particular, has a number of these stocks, allowing the gauge to move ahead of the broader market,” Iwasaki said.

But the analysts weren’t sure the rally will last. Seshimo points out that these indexes have more volatility, and any downturns can also be more pronounced. He said he’s watching for any steep deterioration in global growth.

“If things get really bad, there is a chance of a huge downward correction,” he said.

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