The Japanese stock market enters 2017 on a roll. The broad Topix index has risen 17.6% since a dip in early November. While still 9.5% off highs set in mid-2015, Japanese equities are well ahead of their level when Prime Minister Shinzo Abe took office in 2012.
Despite reservations that emerged in 2016, "Abenomics" appears to have received an injection of optimism based on Abe's strong majority in government and high popularity. He faces a monumental challenge in turning around Japan's moribund economy, but some market watchers are confident he can effect change.
Byron Wien, now one of the key investment minds at Blackstone (BX) , said in his list of 10 surprises for 2017 that the Japanese stock market will lead developed markets globally, a beneficiary of stronger growth in both China and the United States.
The yen will also weaken to ¥130 to the dollar, from ¥114 now, Wien predicts. That would be a decline of 30.2%, almost one-third since it last breached ¥100 to the dollar in mid-August last year. The Japanese currency is already down 14.3% from that point.
Against that backdrop, the investment bank Nomura (NMR) has identified "seven stars" in the Japanese stock market for 2017.
Part of its thinking emanated from an artificial-intelligence review of its research. Through that, it believes it has objectively identified industrial electronics as the most bullish sector in Japan right now, followed by factory engineering and shipbuilding, retailing, steel and nonferrous metals, wires and cable, and the Internet.
Stock picking will be essential as we proceed in the new year, Nomura believes. The bank is concerned that Japanese equities have rallied more than 30% from June 24. While that mimics similar runs in October 2012 and October 2014, this rally does not appear to be driven by anything happening in Japan other than the weakening of the yen. Broadly speaking, the Nikkei 225 may trade in a narrow range after testing its 2015 high, Nomura says.
Here are the "stars," each one from a different sector.
Isetan Mitsukoshi Holdings (IMHDF) , which owns the Mitsukoshi and Isetan department store chains, has been overhauling its business and changing its strategy. That involves a focus on greater profitability, with ¥40 billion ($350 million) in cost reductions through headcount reductions and other methods over the next four years.
The company is also attempting to convert asset value into income. One example is a redevelopment in Shinjuku that is bringing in outside developers as well as the government. Nomura expects the earnings to turn around not immediately but in the mid-term, hitting bottom this fiscal year, which ends in March.
Trend Micro (TMICY) is Japan's largest security-software company. With concern over corporate and government security gaining ground every day, its products will be in increased demand, the investment bank notes. The advent of the Internet of Things will also drive a desire among consumers to protect data and their products, now more closely linked to themselves.
Trend Micro acquired the U.S. security-software rival TippingPoint in 2016. That purchase should help the Japanese company raise its international profile and market share, combining endpoint security with network security.
Konica Minolta (KNCAY) may be most familiar to consumers as the owner of two famed camera brands, but it divested those businesses in 2006. It now focuses on business equipment such as copies and laser printers as well as industrial-imaging products such as X-ray film and X-ray processors.
Nomura highlights the company's pioneering role in "ESG" initiatives: environmental, governance and social-responsibility responsibility. Through those functions, it is attempting to boost productivity by improving the physical and mental health of employees, and reducing its environmental burden. Facing a highly competitive market for office equipment, the company is pushing to improve the profitability of existing operations, to strengthen its position in money-spinning peripheral products and to create business lines suited to the Internet of Things.
Kawasaki Heavy Industries (KWHIY) , which makes the motorbike brand as well as heavy equipment and defense systems, has earnings that are driven significantly by its foreign currency exposure. That means it will get a major boost from the recent depreciation of the yen. Its precision-machinery segment is seeing a recovery in demand for the hydraulic equipment used in construction machinery and robots.
The company still has issues to address in its shipping and offshore-structure business, which incurred extra costs this fiscal year. But a consolidation of that segment, including a review of how sustainable the entire business is, will end this business year.
Mitsubishi Motors T:7211, the car maker, should see a strong recovery in earnings for the 2017/18 fiscal year, ending in March 2018. That stems from new products that it has released such as compact sports/utility vehicles globally, and minivans in Indonesia.
The company is also benefitting from its cooperative efforts with Nissan Motor (NSANY) . This will reduce procurement costs and result in substantial sales growth, since Mitsubishi is supplying cars of its own development to Nissan, while Nissan fills out Mitsubishi's product line with products the company lacks.
Mizuho Financial Group (MFG) has lagged other large banks as they recovered after the election of Donald Trump. Mizuho is also streamlining its balance sheet and improving its efficiency on costs, measures that the Japanese banking industry is now focusing on.
The sustained growth in noninterest income stems from its balance-sheet improvements. In terms of efficiency, the bank stepped up an "Operational Excellence" program starting this fiscal year.
Softbank Group (SFTBY) is one of Japan's most forward-thinking companies, to my mind. It started as a software company but has advanced into a broad range of technology businesses, as well as banking, telecommunications and private-equity investment. It bought the U.S. phone company Sprint in 2012.
Earnings should be on an upward trajectory over the mid-term in its key markets: Japan, the United States, China and the United Kingdom. The company is also prepping its Softbank Vision Fund for launch. Nomura expects the company's pretax profits to hit ¥1.02 trillion ($8.95 billion) next fiscal year, ending in March 2018. One key factor to watch is any improvement in earnings at Sprint. Nomura has set a target price of ¥11,110 ($97) for the stock, meaning it is undervalued at its current level of ¥8,350 ($73).
Nomura has therefore added Konica Minolta and Softbank to its model portfolio. The bank admits that the portfolio lagged badly in 2016, underperforming the Topix by 5% over the year. That was the worst performance since 2009, although it did not destroy entirely the 9.5% outperformance over the Topix of the prior year.
Structural factors to consider
These stocks should perform well, the investment bank believes, in the "post-preview" era. Japanese companies have abandoned the practice of providing earnings previews, as they had done and at times selectively, since September 2016 when the Japan Securities Dealers Association issued guidelines to that effect. It is a stance similar to that implemented in the United States after Regulation Fair Disclosure or "Reg FD" came into effect. The Japanese equity market appears to have yet to respond to this move.
Another structural issue that investors might want to consider when looking at the Japanese market is the large amount of exchange-traded funds that the Bank of Japan has been buying, as part of the central bank's participation in Abenomics efforts to reform the economy and drive inflation. The BOJ will likely cut the rate of its purchases for the first time at its April meeting, Nomura says, down between ¥1 trillion and ¥1.5 trillion from ¥6 trillion ($53 billion) per year now. This market exposure could result in excessive risk-taking from the central bank if stocks slide -- higher prices, of course, present no problem.
It remains to be seen how the central bank will dispose of its acquired stock. Hong Kong may provide a model for how the BOJ will ultimately dispose of its ETF portfolio.
The Hong Kong Monetary Authority bought up a large part of the Hong Kong stock market during the Asian financial crisis only to return the shares back to the market in the form of the Tracker Fund HK:2800, the city's first ETF, over the course of three years. This move encouraged retail investors to buy equities.
The BOJ might consider a wider range of ETFs rather than one "lump sum," Nomura says, such as carving out sector ETFs that might appeal even more to investors.