What Are The Recent Drivers For Japan?
The Nikkei 225 has been enjoying a strong rally. Our research desk explores the reasons behind this.
by Mah Ching Cheng
The Japanese market has been going through quite a rally in the past two months. Just in the month of August and September (till end 26 Sep 2005), the market, represented by Nikkei 225, rose by 12.5% (in Japanese Yen or JPY terms). Now the Nikkei 225 is at about 13,400 points, which is at a four-year high. What are the reasons for the sudden strong rally in a market that had made many investors disappointed after the technology bubble days? We think that there are basically three main reasons. The first reason was the anticipation of further improvements to the Japanese economy, should either Koizumi or Okada, be elected as Prime Minster. Both of them have talked about measures such as cutting government spending, reducing national debt and balancing the deficit within a decade. However, when Koizumi emerged as the winner for the elections on 11 September 2005, the response from investors was even better than anticipated. Investors were keen to invest more in equities as Koizumi’s successful re-election was seen as the people of Japan giving him a mandate to implement the privatization of the post office and other reform plans that he hopes to take upon for the economy. Companies in Japan have also been doing well in terms of profitability. Chart 2 shows that the corporate profit levels have been improving over the past 4 to 5 years. The chart shows the extrapolated profit numbers for 20,000 companies whose capital is over 10 million Yen. Over the past one year (as at June 2005), the corporate profitability rose by 12.9%. As companies reap better profits, investors become more comfortable investing, and that might be one of the underlying factors that pushed markets up. The third reason is the noticeably stronger leading indicator index as shown in chart 3. The leading indicator index combines 12 leading indicators including consumer sentiment, new machinery orders, new job offers and some others. An index above 50 indicates more indicators being positive rather than negative. In June 2005, the index turned to 66.7, which is above the level of 50. The leading indicator index tends to be rather volatile as it went down to 45.5 at the end of July. However, if you observe the chart above, the indicator still seems to be trending up in the past 4 to 5 months. A strong leading indicator index does tell us that in the next three to six months, economic and business sentiment are expected to be rather positive. All in all, the strong corporate profitability, strong sentiment post-election and the strong signals from the leading indicator index are just three of the factors we think could have triggered the recent rally in the Japanese market. The valuation for Japan is relatively not demanding on a historical basis. PE ratios are 21.8X and 19.7X for 2005 and 2006 and earnings growth is estimated to be 9.3% and 10.9% for these respective periods (as at 23 September 2005). Although there is a slew of positive news, we are still neutral on the Japan market based on the fact that we believe that there are other markets that will perform better on a relative basis, for example the Asia excluding Japan market and the Asian technology sector. Nonetheless, we always advocate investors to take a diversified approach in portfolio investing. By having a diversified portfolio, investors can have exposures to different markets when they experience run-ups. For investors that are interested in investing in the Japan market, our recommended Japanese equity funds are OCBC Japan Growth Fund and Henderson Japanese Equity Fund. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund's prospectus. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer .gif)
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