Japanese Stock Market Outlook

SMAM monthly comments & views - March 2015 -

Japanese Economy

Ongoing moderate economic recovery is currently in the middle stage, as robust Exports and Industrial

Production is boosting the economy. The other economic growth driver, Consumption Expenditures falters with

mixed economic data for solid recovery. Wage increase should help to gain Consumption and consumer

confidence, while “Spring wage negotiation round” is in full swing.

• SMAM expects mild real GDP recovery of +1.2% and +1.6% in FY2015 and FY2016 alongside global economic

growth.

• Current recovery polarizes upbeat Exports and Industrial Production, and lagging Consumption.

• Core-CPI is expected to fall to “zero” in May and BOJ is likely to revise its target rate downward, but the timing

of additional monetary easing is controversial.

Japanese Stock Markets

The market is expected to rally on increasingly positive earnings growth as quite a few up-revisions are expected due to weaker JPY at the full-year corporate performance posting in May.

• Corporate earnings growth momentum is likely to accelerate as double digit profit growth is expected in FY2015

(FY2016/3).

• Downside risk is associated with foreign factors such as geopolitical concerns, unclear monetary policy by Fed

and ECB, and possibly negative effects by crude oil price slump.

Executive summary

1

Outlook for Japanese Economy

2

3

SMAM newly rated Real GDP forecast of +1.6% for FY2016, while the forecasts were downgraded to -0.8%

from -0.6% for FY2014 and to +1.2% from +1.3% for FY2015 respectively.

Recently released annualized +2.2% October-December GDP data showed mild recovery. Strong Exports

spurred to expand Industrial Production, while weak Consumption weighed on the slower-than-expected GDP

growth (market consensus of +3.7%) in the quarter.

The BOJ is highly likely to revise downward its +1.0% inflation forecast for FY2015 as SMAM expects Core-

CPI to dip into negative once in May and recover slightly to +0.4% for full FY2015.

Notes: E=SMAM forecasts. SMAM views are as at 16 February 2015 and subject to updates thereafter without notice

Source: Cabinet Office: Bank of Japan, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts

(%, YoY except Net Exports)

SMAM economic outlook for FY14-16

Real GDP growth 0.4% 1.0% 2.1% -0.8% 1.2% 1.6%

Private Consumption Expenditure 1.4% 1.8% 2.5% -3.1% 1.2% 1.7%

Private Housing Investment 3.2% 5.7% 9.3% -11.9% 0.3% 4.2%

Private Capital Investment 4.8% 1.2% 4.0% 0.1% 2.5% 3.2%

Public Consumption Expenditure 1.2% 1.5% 1.6% 0.3% 0.8% 0.6%

Public Capital Investment -3.2% 1.0% 10.3% 2.9% -1.7% -1.6%

Net Exports (contrib. to GDP growth) -1.0% -0.8% -0.5% 0.7% 0.3% 0.1%

Exports -1.6% -1.3% 4.7% 7.2% 5.0% 5.0%

Imports 5.4% 3.6% 6.7% 3.0% 4.0% 5.2%

Nominal GDP -1.3% 0.1% 1.8% 1.2% 1.3% 2.2%

GDP Deflator -1.7% -0.9% -0.3% 2.1% 0.1% 0.5%FY staring April and ending March

FY11 FY12 FY13 FY14E FY16EFY15E

Quarterly GDP: +2.2% GDP growth after 2 straight quarters slowdown

October-December GDP grew annualized +2.2%, bottoming out after 2 consecutive quarters slowdown.

Industrial Production has geared up again since October-December quarter, spurred by upbeat Exports, while

Consumption Expenditures are still improving at slower pace.

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-20

-15

-10

-5

0

5

10

15

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1

12 13 14 15 16 17

Private Consumption Expenditure

Private Housing Investment

Private capital Investment

Public Capital Investment

Others (mostly inventory change)

Net Exports

Real GDP growth

Real GDP growth and Contribution by components(QoQ % annualized)

(Source) Cabinet Office, SMAM forecast

Forecast by SMAM

"Others" consists of mostly Inventory change.

Bottom Out

5

SMAM forecasts this recovery process in order from Exports to Production and Consumption. Now it is the

middle stage of Production expansion.

Stable economic recovery is expected at this time underpinned by robust Exports and Industrial Production

due to US led global economic growth.

Lagging Consumption Expenditures should be buoyed by improvement in Consumer Confidence.

Recovery Process: Exports⇒Production ⇒ (Employment, Confidence) ⇒ Consumption

90

92

94

96

98

100

102

104

106

108

110

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q

12 13 14 15

Exports

Industrial Production

Consumption Expenditure

Exports, Industrial Production and Consumer Expenditure(YR2010=100)

(Source) Ministry of Economy, Trade and Industry, BOJ, Cabinet Office, SMAM seasonally adjusted

*1: Exports for 1Q 2015 are estimated based on the data of first 20 days January prov isional basis.*2: Industrial Production for 1Q 2015 is estimated based on the data of Industrial Production Forecast Index.

Forecast by SMAM

6

Exports: Favorably growing Exports in January

October-December Export volume accelerated to expand to +2.7% QoQ from +1.6% QoQ in July-September.

Exports FOB value basis favorably rose by 14.8% in January (First 20 days Provisional).

85

90

95

100

105

110

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1

12 13 14 15

QoQ Change (LHS)

Export Volume month (RHS)

Export Volume 3mMA (RHS)

(Source) Bank of Japan, SMAM seasonally adjusted* QoQ Change and Export Volume 3mMA for January -March quarter 2015 are estimated based on the data of first 20 days January

Export Volume (YR2010=100)（Export Volume Index）

(Change, %)

Forecast by SMAM

Production: Mild sustainable IP recovery to be expected

October-December Industrial Production recovered by +1.8% QoQ for the first time in 3 quarters.

Production Forecast Index shows robust growth of +6.3% MoM in January and -1.8% MoM in February.

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-30

-20

-10

0

10

20

30

50

60

70

80

90

100

110

120

130

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1

05 06 07 08 09 10 11 12 13 14 15

IP 3mMA QoQ change (RHS)

IP Index (LHS)

Industry Production （IP 3mMA QoQ Change, % ）(YR2010=100)（IP Index）

(Source) Ministry of Economy, Trade and Industry , SMAM seasonally adjusted* IP 3mMA QoQ for January -March quarter 2015 is estimated based on the data of IP Index in January and february 2015

(Upto February 2015)

Consumer Confidence: Slight improvement in Consumer Sentiment

Consumer Confidence Index rebounded for 2 consecutive months by +1.1% MoM in December and +0.3%

MoM in January.

Consumer Sentiment is anticipated to improve, supported by tight labor market. December unemployment rate

fell to 3.4% of the full-employment.

Slower growth in real wages weighs on recovery in Consumption as Scheduled cash earnings (fixed salary) has

not grown much from the previous year. Considerable wage hike is the key for improving consumer confidence.

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30

40

50

60

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012 2 4 6 8 1012

05 06 07 08 09 10 11 12 13 14 15

Nikkei 225 (LHS)

Consumer Confidence Index (RHS)

(Source) Cabinet Office, INDB, Tokyo Stock Exchange

Consumer Confidence Index and NIkkei 225

(Upto January 2015)

(Yen)

9

December Retail Sales slightly rose by +0.2% YoY, while Consumer Expenditures lost by 3.4% YoY in

December.

Consumption tax hike seems to affect more on Consumer Discretionary. December New car sales slumped by

-18.9% YoY.

Mixed Consumption data shows Consumption seems to be still in the middle of full-recovery.

Consumption: Mixed Consumption data showing weak recovery

-10

-5

0

5

10

15

1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12

2013 2014

Consumption Expenditures and Retail Sales

Consumption Expenditures

Retail Sales

(%, YoY)

Consumption Tax Hike

(Source) Ministry of Internal Affairs and Communications

Outlook for Japanese Stock Markets

10

Stock market outlook: Earnings growth prospects should lift up the stock market

SMAM short-term view

Due to lack of major concern over domestic factors, Japanese equity market is anticipated to sustain to rally.

SMAM forecasts positive corporate earnings prospects due to weaker JPY.

Downside risk includes foreign factors such as geopolitical concerns over Greek negotiation and

Russia/Ukraine cease-fire, uncertain monetary policy in Fed and ECB, and possibly negative effects to global

economy and capital market led by crude oil price plunge.

Longer-term outlook (6-month and beyond) For longer-term, we continue to expect the market to track on a modest uptrend, underpinned by US-led

moderate global growth, solid corporate earnings growth and strengthened reflationary policies in Japan.

Note: SMAM’s Projection is as at 18 February 2015 and subject to updates without notice

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500

700

900

1,100

1,300

1,500

1,700

Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

Topix

Upside Range

Downside Range

TOPIX index range expectation by SMAM's Projection

(Source) TOPIX: Tokyo stock exchange, Upside and Downside range: forecasted by SMAM

(Points)

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views:

• Global economic recovery to be sustained led by strong US economy

• Japan’s mild recovery from tax-hit weak demand buoyed by rescheduled next tax hike until 2017

• Growing expectation for positive corporate earnings revisions due to weaker JPY

• Reflationary policy to be continued toward the next consumption tax hike

Upside Risks include:

• Stronger-than-expected global growth

• Stronger-than-expected measures by Abe government

Downside Risks include:

• Slowdown in global economy

• Concern over global deflation

• Increasing geopolitical concerns

12

Global recovery: Global PMI Vs. TOPIX

PMI is often used as a leading economic indicator. There seems some correlation between TOPIX and Global

PMI as many Japanese companies increase their profits while global economy are growing.

Recent sharp improvement in Global PMI would help to lift up the Japanese equity market index although

corporate profits are often lagging to grow from the economic data.

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-30%

-20%

-10%

0%

10%

20%

30%

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

May-12 Nov-12 May-13 Nov-13 May-14 Nov-14

GLOBAL PMI and TOPIX (3month Chg, %)

Global PMI (LHS)

TOPIX (RHS)

(Source) Thomson Reuters Upto 31th January 2015

EPS forecasts: Upbeat EPS forecasts

IBES consensus EPS continues rising supported by solid growth prospects. IBES 12 month forward EPS and

18 month forward EPS are 106.80 and 102.17, while TOPIX EPS is currently 90.74 as of 13th February.

SMAM revised down corporate profit growth to +7.6% YoY from +11.2% YoY for its research universe 200

companies (ex. Financials) for FY2014 as resource businesses such as petroleum and mining posted write-off

in October-December quarter led by lower oil price.

However, SMAM expects +14.8% profit growth in FY2015 as corporate earnings are expected to continue

solid recover due to global economic growth and stabilized oil prices.

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60

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100

120

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

TOPIX EPS and IBES forward EPS (12month&18month)

TOPIX EPS

IBES forward EPS (12m)

IBES forward EPS (18m)

Up to February 13th 2015(Source) IBES 12month forward EPS, SMAM

106.80

102.17

90.74

TOPIX range forecast: Fairly valued but profit growth momentum accelerated

IBES 12 month forward EPS forecast for TOPIX was JPY102.17 as of February 13 2015. P/E has ranged

between 13x and 15x since Abe government resumed. Based on these values, TOPIX is estimated to be

between 1,328 and 1,532. This shows current Japanese stocks and TOPIX of 1,482 as of February 18 are fairly

valued within this range.

SMAM expects +7.6% and +14.8% profit growth in FY2014 and FY2015 for the research universe 200

companies (ex. Financials). Corporate profit growth momentum is going to accelerate.

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300

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1,100

1,300

1,500

1,700

1,900

Feb-05 Dec-05 Oct-06 Aug-07 Jun-08 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 Jun-13 Apr-14 Feb-15

TOPIX and P/E based on IBES 12month forward EPS

TOPIX P/E 11x P/E 12xP/E 13x P/E 14x P/E 15xP/E 16x

*1: Calender year, week-end Topix, PEx based on IBES 12month forward EPS

*2: SMAM forecast is expected based on earnings projection of ERG core univers (ex. Financials)

(Source) Tokyo Stock Exchange, IBES 12month forward EPS, SMAM

Up to February 13th 2015

Supply / Demand analysis: Program / Arbitrage trading buy positions Vs. Nikkei 225

The stock market would often advance while the buy positions for Program / Arbitrage trading (=cash and carry

positions) are increasing. Many of those positions are closed by reversing sell transactions and the market

would often decline.

The Chart shows Nikkei 225 Index gained alongside the increasing in Program / Arbitrage buy positions for the

period 2013-2014. However, Nikkei is moving higher, while the buy positions are growing little in 2015. Current

rally is likely to continue under the light selling pressure.

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16,000

18,000

20,000

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

Program/Arbitrage Trading Buy Positions and Nikkei 225

Arbitrage Trading Buy Positions (LHS)

Nikkei 225 (RHS)

(Source) Tokyo Stock Exchange Upto 16th February 2015

(JPY Million)

17

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investment strategies and opportunities. Therefore this material is not intended to offer or solicit investments, provide investment advice or service, or to be considered as disclosure documents under the Financial Instruments and Exchange Law of Japan.

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