Traders Turn Nervous on Japan Stocks After Remarkable Ascent

(Bloomberg) -- Going uphill is looking increasingly unlikely for Japanese stocks that are about to cap their best quarter since at least 2016.

Recent events are starting to make some investors nervous, leading to a selloff in Japanese stocks by foreign holders. U.S. Sun Belt states are wrestling with mounting coronavirus cases, while the European Union works to bar Americans from traveling to the bloc. In addition, tensions between the U.S. and China are ratcheting up again, moving beyond trade threats to exchanging regulatory punches.

“Upside is limited,” said Toru Ibayashi, the head of Japanese equities research at UBS Wealth Management. “Valuation is too high, expectations are too optimistic,” and earnings estimates are “sluggish,” he said.

Along with global stocks, Japanese shares staged a remarkable comeback from March as virus cases slowed and the Bank of Japan aggressively bought exchange-traded funds. The Topix is poised to end the April-June period with a 12% climb, the best quarter since 2016. As a result, the index is trading at about 17 times its next year’s profits, the highest in 10 years.

The concerns are also local. Ibayashi is worried that the pandemic severely damaged most Japanese companies during the shutdown in May and June. This could trigger a consolidation in industries -- namely apparel makers, retail stores and hotels -- that are dependent on offline spending, he wrote in a note.

Polarized Market

The lack of breadth across the stock market also worries fund managers at firms such as BNY Mellon Asset Management Japan Ltd. and Ichiyoshi Asset Management Co.

Among the constituents in the blue chip index Nikkei 225 Stock Average, less than 30 have risen year-to-date, while a majority of stocks remain in the red. Top performers include Chugai Pharmaceutical Co., medical information provider M3 Inc., and door-to-door parcel delivery service operator Yamato Holdings Co. Pharmaceuticals and telecommunications are the only winners among the Topix’s 33 groups.

“Gains are propelled by a small number of stocks” as the market gets polarized, said Masafumi Oshiden, a fund manager at BNY Mellon Asset Management, adding that industries hit by the virus include road and marine transportation, while real-estate sectors remain under pressure. “The concentration on ‘growth stocks’ is a bit scary.”

Investor appetite is centered around stocks that will benefit in a world where lifestyles have been changed by the coronavirus, which includes those related to health care and remote-working practices, said Mitsushige Akino, a senior executive officer at Ichiyoshi Asset. Overall, growth stocks, whose earnings and sales are expected to increase at a relatively fast rate, are dominating markets, whereas value stocks that are closely-linked to business cycles, are lagging, he said.

For UBS Wealth’s Ibayashi, Japan’s equity market will need additional positive news to justify further gains.

“The stock market is already near pre-pandemic levels. If the stock market should go up, past pre-pandemic levels, something positive should be happening,” Ibayashi said. “What is it?”

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