Japan’s
stock
market
hit
record
highs
last
month,
so
investors
have
high
hopes
it
can
be
another
bumper
year
for
the
country’s
domestic
index.
Nevertheless,
its
first
interest
rate
rise
in
17
years
complicates
the
outlook
for
investors,
as
I
discussed
in
a
recent
article.
What
often
gets
overlooked
in
discussions
of
“record
highs”
is
that
certain
individual
stocks
are
driving
these
index
increases.
In
this
case,
companies
like
Toyota
Motor
(7203)
have
posted
explosive
growth,
with
shares
up
nearly
100%
over
one
year.
Because
of
the
weaker
currency,
it’s
been
a
boom
time
for
exporters
like
Toyota,
which
makes
up
the
largest
part
of
the
Morningstar
Japan
Index,
which
itself
holds
more
than
1,000
stocks.
Morningstar
analysts
cover
69
of
those
Tokyo-listed
stocks
and
24
are
rated
as
4-
or
5-Star
stocks,
which
screen
as
undervalued.
Just
two,
Nissan
Motor
Company
(7201)
and
chemicals
firm
KOSE
(4922)
are
considered
significantly
undervalued,
according
to
our
metrics.
That
24
remain
undervalued
may
seem
surprising
given
the
strength
of
Japan’s
market
rally.
The
table
below
indicates
which
sectors
are
overvalued
or
undervalued:
consumer
defensive,
industrials
and
technology
are
well
represented
in
the
4-star
cohort.
The
quarterly
Tankan
survey
has
just
been
released
by
the
Bank
of
the
Japan,
and
it
showed
services
in
good
health,
helped
by
the
lure
of
cheap
currency
for
tourists;
but
manufacturing
sector
growth,
while
still
strong
(and
better
than
Europe),
has
started
to
flag.
The
yen
actually
fell
further
after
the
rate
rise,
which
goes
against
basic
economics,
which
would
normally
posit
that
tighter
monetary
policy
pushes
up
currencies.
But
there
are
a
lot
of
moving
parts
in
the
global
economy
this
year.
A
lot
depends
on
when
the
Federal
Reserve
starts
cutting
rates,
especially
as
June
now
looks
less
likely.
Many
experts,
such
as
Columbia
Threadneedle
chief
economist
Steven
Bell,
expect
the
Bank
of
Japan
to
take
“baby
steps”
in
raising
interest
rates.
What’s
Going
on
in
Japan’s
Economy?
•
Tourism
is
booming;
•
Services
growth
is
strong;
•
The
yen
remains
at
multi-decade
lows;
• Japan
avoided
a
technical
recession –
just;
•
Large-cap
stocks
have
performed
well.
Can
Japan’s
Small
Cap
Stocks
Catch
Up?
An
appreciating
yen
could
still
disrupt
the
gains
of
the
exporting
stocks.
Would
small-
and
mid-cap
stocks,
which
have
lagged
their
larger
peers,
then
catch
up?
That’s
the
view
of
Joe
Bauernfreund,
who
runs
the
manager
of
the
AVI
Japan
Opportunity
(AJOT)
trust.
He
argues
corporate
governance
reforms
have
been
led
by
the
larger
capitalised
stocks,
with
smaller
companies
previously
under
“no
pressure
to
do
a
better
job”.
Now
they
have
to
focus
more
sharply
on
shareholder
returns
and
profitability.
But
that
still
leaves
a
raft
of
underappreciated
companies
in
Japan,
he
says,
many
of
which
have
attracted
the
interest
of
the
burgeoning
private
equity
sector
in
Tokyo.
Morningstar
analyst
Lorraine
Tan
argues
that,
when
they
come,
rate
rises
will
favour
financial
services
because
of
net
interest
margins.
But
the
gains
of
inflation
and
positive
interest
rates
can
be
more
broadly
shared
–
and
even
if
the
yen
rises,
this
will
not
make
a
big
difference
to
returns
seen
by
foreign
investors.
“We
think
the
main
reason
overseas
investors
can
be
long-term
positive
on
Japan
is
the
return
of
inflation
will
provide
a
boost
to
spending
and
drive
capital
reinvestment,”
Tan
says.
“Its
decades-long
deflation
discouraged
Japanese
companies
from
reinvesting
domestically
and
also
saw
house
prices
slip.
Now
that
there
appears
to
be
some
prospect
of
rising
prices,
we
hope
that
this
will
lead
to
a
sustained
changed
mindset
towards
domestic
investment,
and
that
this
will
lead
to
increased
consumption.
“However,
should
the
yen
appreciate
as
quickly
as
it
fell,
some
of
these
drivers
could
be
diminished.
We
think
overseas
investors,
however,
should
be
hedged
in
that
regard
as
a
strengthening
yen
should
help
counter
a
possible
slip
in
share
prices.”
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