Japan’s Stocks Hit a 27-Year High, But Not Because of the Usual Suspects

(Bloomberg) -- Japan’s blue-chip Nikkei 225 Stock Average soared to its highest in almost 27 years, but it’s not the usual suspects -- the country’s giant exporters -- that have been leading the charge this year.

Retailers, drugmakers and other more defensive shares have been driving the increase, with companies such as Fast Retailing Co., FamilyMart UNY Holdings Co., Eisai Co. and KDDI Corp. at the forefront. On the broader Topix index, which hasn’t recovered as quickly as the Nikkei 225, pharmaceutical companies, utilities and service firms have been among the standout performers.

The Nikkei 225’s turnaround this year has been fast and decisive. It’s up almost 9 percent from a recent low on Sept. 7. The best performance among markets in Asia during that time has sent the gauge into the green for the year after months when it struggled to gain ground. But while the recent rally has been brisk, some money managers say it’s lacking in confidence.

“People had doubts over whether the global economy will continue to fare well,” said Kiyoshi Ishigane, chief strategist at Mitsubishi UFJ Kokusai Asset Management Co. in Tokyo. “They had little choice but to go for defensives.”

Japan’s Stocks Hit a 27-Year High, But Not Because of the Usual Suspects

Investors have been grappling with uncertainties in the global economy and at home. They’ve been watching the fallout of U.S. President Donald Trump’s trade war with China, while domestically the prospect of another increase in the sales tax next year looms on the horizon.

At the same time, there are signs the Japanese and world economies are powering ahead. Revised second-quarter data last week showed the U.S. economy expanded at a 4.2 percent annualized pace -- the fastest since 2014. And Japan’s economy grew at the fastest pace in more than two years during the second quarter, as the country witnesses its longest stretch of economic growth in a generation.

Japanese stocks have been playing catchup after underperforming U.S. equities this year. That’s on show in the valuations. The Topix trades at about 14 times estimated earnings and the Nikkei 225 at about 17 times. That compares with 18 times for the S&P 500 Index.

“The economy was good but then investors started growing conscious over the possibility of a global peak-out," said Kazuyuki Terao, chief investment officer for the Japan arm of Allianz Global Investors. “That, coupled with trade war worries, pushed money into defensives.”

Both Ishigane and Terao note that the market has more risks ahead.

Trade, Rates

Ishigane points out that a stronger-than-expected U.S. economy could mean a more hawkish Federal Reserve and push up global interest rates, which contributed to a spike in volatility and a global equity rout in February. Terao is more wary of trade issues, noting that the market needs to see how U.S. Donald Trump’s stance towards trade changes, if at all, following mid-term elections in November.

In one positive sign for global trade, the U.S. and Canada agreed to a deal with Mexico, setting the stage for their leaders to sign an accord by late November.

The surge in the Nikkei 225 was at least partly due to the price-weighted nature of the index. The gauge’s two top stocks by weighting, Fast Retailing Co. and SoftBank Group Corp., account for more than 14 percent of the measure. And they’ve both climbed at least 28 percent this year.

It’s also worth noting that the Nikkei has regained its more than quarter-century high despite huge selling by foreign investors for most of the year. But that, says Ishigane, is a reason for optimism.

“I see the rally continuing,” he said. “Foreigners are likely to return to Japanese stocks. Japan fell behind the others in the rally while the U.S. zoomed ahead. They can’t help but increase their weighting to Japan.”

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