Record liquidity and low interest rates
The below graph reflects the high level of liquidity held by Japanese corporations (the blue line on the left axis). The yellow line (left axis) reflects the low expectation that interest rates on loans will rise anytime soon, as Japanese corporations have been deleveraging into a low-growth domestic economy for decades. The red line reflects the willingness of Japanese banks to lend—nearly the best levels we’ve seen since 2007. With ultra low rates, ultra high cash levels, and growing corporate profits in Japan, this data would suggest the growth of a positive environment for Japanese equities.
The Nikkei equity index leads banking data
As the above graph reflects, the Japanese equity market (the black line on the right axis) leads and outpaces the banking data. The banking data suggests that banks are in a good position to extend loan growth. The recent pick-up in Japanese corporate profits suggests that the corporations are in a better position to borrow. The rise in the Nikkei equity index (the black line) reflects the increase in corporate profits due to the weakening yen. The Nikkei index stands at approximately 15,000—roughly 6.0% off its December 31, 2013, close, though still below its pre-2008 crisis peak of closer to 18,000. In contrast, the U.S. S&P 500 is 21% above its peak. The TOPIX broad index shows a February price-to-earnings ratio of 22.2 times versus nearly 20 times in the S&P 500, with a price-to-book ratio of 1.1 times in the TOPIX, versus 2.78 in the S&P 500.
This suggests that Japanese companies trade at a very low multiple to book value, though with a similar price-to-earnings ratio as U.S. shares. Relative to the USA, Japan’s broad equity market is looking a bit like a value stock, with a low price-to-book ratio. However, with a similar price-to-earnings ratio, it might appear that revenue growth is factored into the overall market value of Japanese shares at a reasonable level.
To see how the outlook for growing corporate profits is supporting the Japanese equity market, please see the next article in this series.
For an overview of the U.S. macroeconomic recovery that could support Japan’s export economy, please see 2014 US macro outlook: The crack in the debt ceiling.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of the Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). Plus, as Japan pursues unprecedented monetary expansion and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV). For more on how the U.S. Fed’s recent announcements could impact global equities, please see Will the Fed take a bite out of Apple?