Can Japan’s stock market finally deliver value for investors in 2011? The market is unchanged in Yen terms in 2010 but up almost 12% in US$ terms due to the strength of the Japanese currency versus the US$.
Back in November 1996, then Prime Minister Hashimoto announced plans for an acceleration and broadening of financial reforms in Japan. The purpose was to reform the state of the Tokyo stock market- which had deteriorated significantly to the point that from being a global financial center, its status in Asia was now challenged by Hong Kong and Singapore. Fourteen years later Tokyo now has to contend with Shanghai as well.
The collapse of Yamaichi Securities and Maruso Securities in 1997 created hopes that regulators were beginning to let the market function properly. False hopes for investors, however, as the stock market has never been able to provide positive returns for the past decade.
Annualized returns, US$
Source: MSCI Barra
One potential catalyst for Japanese equities in 2011 is the proposed 5% cut in corporate income tax. This would encourage foreign investors to buy equities. In 2010 offshore investors have bought around 2.5 trillion Yen worth of Japanese equities, up from 2009 and 2008 but significantly lower than in the 2003-2006 period (average of 6 trillion Yen annually).
A switch from bonds into equities by local investors is also possible since currently 10-yr bonds yield 1.1% while 3-months fetch barely above 0.1%. It is reasonable to assume that rates cannot go lower and the potential steepening of the curve (10yr- 2yr) will be positive for equities. Stock and bond returns are negatively correlated.
Valuation-wise, Japanese stocks appear cheap versus their global peers. Non-financials are trading on a free-cash flow yield of 9% compared with less than 6% for the world ex-Japan. Japanese banks trade at a price-to-book multiple of around 1x versus 2x for the world ex-Japan. Further, most companies have significant capacity to increase dividends to shareholders.