Why Cheap, Ignored Japan Stocks May Soon Surprise

(Bloomberg) -- One of the biggest headwinds for Japanese stocks at the moment, despite trading near their highest this year, is investors just don’t seem all that excited.

Average trading volumes this year are down more than 50 percent from their 5-year mean, worse than those in Europe and the U.S., and a world away from China, which is running about 60 percent above average, according to data compiled by Bloomberg. Foreign investors have made net sales of more than $17 billion of Japanese equities through April 10, according to EPFR data compiled by Jefferies.

“Mention Japanese equities in the title of a research report and typically readership will plummet,” said Andrew Lapthorne, global head of quantitative strategy at Societe Generale SA, in a note Monday. “Too many have been disappointed by Japanese equities despite a fundamental story that in our view remains appealing.”

Japan’s Topix Index was little changed Tuesday after hitting a December high as the first round of trade talks with the U.S. continues in Washington. Stocks across the Asia Pacific region were mixed, while U.S. equity futures inched higher.

For Japan, a near 9 percent rise in the Topix this year still lags many of its Asian peers, underscoring just how difficult it remains to build a bull case for equities in a country facing long-term growth and demographic headwinds.

Lapthorne’s argument for Japan is two-fold:

• While U.S. companies have spent the past 10 years increasing leverage on their balance sheets, Japanese counterparts have been doing the opposite. Japanese profits have also been strong, further bolstering balance sheets.
• Valuations are also attractive, with forward earnings yields showing not only are there plenty of cheap stocks but also a much wider range of them. By contrast U.S. shares are not only looking increasingly expensive, but are also clustered around a more expensive mean.

Meanwhile, one of Japan’s biggest investors in both stocks and bonds looks likely to continue its stimulus program.

It’s vital for the Bank of Japan to continue persistently with powerful monetary easing, Governor Haruhiko Kuroda said in response to questions in parliament Tuesday. The BOJ’s purchases of equity ETFs are to help achieve price stability, he said.

The central bank expects Japan’s economy to continue its moderate expansion as the global economy picks up in the second half of the year, and will also be watching how Japan’s falling population weighs on regional banks’ profitability.

Aging Population

Speaking of aging, it remains one of the biggest overhangs for Japan’s economy and markets, and the debate over pension reform is likely to return soon, according to Robert Feldman, senior advisor at Morgan Stanley MUFG Securities, in an April 15 note.

He suggests raising the standard retirement age in Japan to 76 in 2040, which would lower the ratio of government pension payments to GDP to about 6 percent from current levels of almost 11 percent. If the retirement age was left at 65, that ratio would range from 9.5 to 12.25 percent, depending on productivity growth.

“All scenarios on setting an SRA require major increases of productivity” either from the young or the old, depending on the route Japan takes, Feldman concludes. “In either case, major investments are needed in human, physical and intangible capital.”

Stock-Market Summary

• MSCI Asia Pacific Index up 0.2%
• Japan’s Topix index little changed; Nikkei 225 up 0.2%
• Hong Kong’s Hang Seng Index up 0.6%; Hang Seng China Enterprises up 1.1%; Shanghai Composite up 1.1%; CSI 300 up 1.4%
• Taiwan’s Taiex index up 0.3%
• South Korea’s Kospi index little changed; Kospi 200 up 0.2%
• Australia’s S&P/ASX 200 up 0.3%; New Zealand’s S&P/NZX 50 up 0.5%
• India’s S&P BSE Sensex Index up 0.9%; NSE Nifty 50 up 0.8%
• Singapore’s Straits Times Index up 0.1%; Malaysia’s KLCI little changed; Philippine Stock Exchange Index up 0.8%; Jakarta Composite up 0.2%; Vietnam’s VN Index down 1.3%
• S&P 500 e-mini futures up 0.1% after index closed little changed in last session

To contact the reporter on this story: Eric Lam in Hong Kong at elam87@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Cormac Mullen, Kurt Schussler

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