Co-ordinated fiscal and monetary policy support should continue to help equities while economic data seems to be moving generally in favour of Japan.
PMI indices have been moving up, unemployment rates are low, with indications that wage rises will continue into the future, and a weaker yen should boost inbound tourism.
From a valuation perspective, Japanese equities remain among the cheapest in the developed world, both relative to their history and compared with other developed countries.
Japanese stocks currently trade at a 1.4 price-to-book ratio, compared with 2.2 price-to-book ratio of global equities, according to the MSCI Japan index v MSCI World index.
A year of two halves
Looking back, the Japanese stock market barely moved in 2016, with the Topix index rising by just 0.31% in yen terms but, thanks to a plunge in sterling, UK investors benefited from a 23.4% return.
This was a year of two halves for investors in Japan, largely driven by currency movements.
At the start of the year, the yen stood at 165 to the pound.
By mid-year it had appreciated to 125, only to fall back to 145 by December. This coincided with market weakness in the first half as the Topix fell by 18.54% in jpy terms, and strength in the second half, with a gain of 23.15%.
Material value
The exchange rate matters enormously to Japan as it remains one of the world’s major exporting countries, with a stronger currency tending to hurt profits of large exporters, such as Toyota and Honda, and vice versa.
Another key characteristic of 2016 was a reversal in sector leadership in both July and August. The valuations of defensive, low-volatility areas of the market such as foods, pharmaceutical and information and communication became overstretched after many years of outperformance.
As a result, market leadership switched instead to more cyclical areas, such as materials, machinery and electric appliances. This rotation was further reinforced by the Bank of Japan’s change of policy in September.
The focus on the yield curve over monetary policy provided a strong tailwind for financials, which were among the strongest-performing stocks in the second half of the year.
