Japanese Stock Market Outlook

SMAM monthly comments & views - November 2017 -

Japanese Economy PM Abe led governing coalition parties won the lower house election on October 22nd. Current economic reform as well as extra easy monetary policy will continue, though a lot of political power might be consumed for debating the constitutional change. Good economic fundamentals continue for Japan supported by solid growth by each segment. • BOJ “Tankan” business survey in September showed robust business sentiment for both manufacturing and non-

manufacturing companies. • Both in Purchasing Power Parity and real yield differentials, current USD/JPY exchange rate around 110 seems to be

appropriate. Future course will depend on how inflation and interest rates move in both countries.

Japanese Stock Markets After renewing the record of consecutive days of rising, the Japanese stock market is going to have a breather in the short term. Robust economic and business fundamentals should support the stock prices. The biggest domestic event, general election, is now behind and the focus is back on overseas events such as North Korea and US politics. • In the long-term, the global economy is expected to grow in a steady undertone. Earnings for the Japanese companies are

expected to be revised upward, which will provide the stimulus to the stock market. • Risk factors are such as North Korea situation, possible slowdown in Chinese economy, US budget debate and effects of

monetary policy change in EU and US.

Executive summary

1

Notes: Macro and market views are as of Oct 23rd 2017, and subject to updates thereafter without notice.

Outlook for Japanese Economy

2

3

Good economic fundamentals continue for Japan supported by solid growth by each segment.

CPI is expected to rise just mildly.

Notes: E=SMAM forecasts. SMAM views are as of Oct. 23rd , 2017 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 FY17-18

( YoY %)

Real GDP growth 2.6% -0.5% 1.3% 1.3% 1.5% 1.1% Private Consumption Expenditure 2.7% -2.6% 0.6% 0.7% 1.3% 0.7% Private Housing Investment 8.3% -9.9% 2.8% 6.6% 2.4% 2.3% Private Capital Investment 7.0% 2.4% 0.6% 2.4% 3.0% 2.7% Public Consumption Expenditure 1.7% 0.4% 2.0% 0.4% 0.7% 0.7% Public Capital Investment 8.6% -2.1% -1.9% -3.2% 3.4% -1.4%Net Exports (contrib. to GDP growth) -0.5% 0.6% 0.1% 0.7% 0.2% 0.2% Exports 4.4% 8.8% 0.7% 3.2% 5.1% 3.0% Imports 7.1% 4.3% 0.2% -1.4% 3.6% 1.7%Nominal GDP 2.6% 2.0% 2.7% 1.1% 1.6% 1.7%GDP Deflator 0.0% 2.5% 1.5% -0.2% 0.1% 0.5%Industrial Production 3.0% -0.4% -1.4% 1.5% 4.5% 2.5%CPI (excl. fresh food) 0.8% 0.9% -0.1% -0.2% 0.6% 0.7%

FY16 FY18EFY13 FY14 FY15 FY17E

4

IMF revised world economic growth forecast upward in October World economic growth is gathering momentum, which is supportive for the stock markets.

IMF World Economic Outlook

GDP (YOY%)

2016 2017 2018 2017 2018

(H) (F) (F)World 3.2 3.6 3.7 0.1 0.1

Advanced Economies 1.7 2.2 2.0 0.2 0.1USA 1.5 2.2 2.3 0.1 0.2Euro area 1.8 2.1 1.9 0.2 0.2Japan 1.0 1.5 0.7 0.2 0.1UK 1.8 1.7 1.5 0.0 0.0

Developing Economies 4.3 4.6 4.9 0.0 0.1CIS 0.4 2.1 2.1 0.4 0.0Emerging Asia 6.4 6.5 6.5 0.0 0.0

China 6.7 6.8 6.5 0.1 0.1India 7.1 6.7 7.4 ▲ 0.5 ▲ 0.3ASEAN5 4.9 5.2 5.2 0.1 0.0

Emerging Europe 3.1 4.5 3.5 1.0 0.3Latin America ▲ 0.9 1.2 1.9 0.2 0.0

Brazil ▲ 3.6 0.7 1.5 0.4 0.2Mexico 2.3 2.1 1.9 0.2 ▲ 0.1

(Source) IMF, compiled by SMAM

Change from theforecast in July

As of October 2017

Change from the forecast in July (2017+2018)

-1.0 -0.5 0.0 0.5 1.0 1.5

Advanced Economies

USA

Euro area

Japan

UK

Developing Economies

CIS

Emerging Asia

China

India

ASEAN5

Emerging Europe

Latin America

(% change)

Note: Data is from Jan. 2008 to Aug. 2017(Source) Bank of Japan

Consumption Activity Index (total)(2010=100, seasonally adjusted, foreign visitors consumption adjusted)

93959799

101103105107109

08 09 10 11 12 13 14 15 16 17

Private consumption growth remains moderate meanwhile consumer sentiment is improving After a robust growth in 2Q 2017, private consumption has lost some momentum lately. Extremely rainy August

was partly blamed for this slow down.

However, consumer sentiment actually improved in recent months as Economy Watchers DI showed. Job security in a tight labor condition is one of the positive factors behind.

5

(Year)

51.3

10

20

30

40

50

60

Economy Watchers DI

Notes: Diffusion indices of "Economy Watchers Survey". DI above 50 means condition is improving. Data period is from Jan. 2006 to Sep 2017.(Source) Cabinet Office

6

Labor market gets tighter and tighter Number of unfilled job vacancy keeps climbing in the face of decreasing number of job seekers.

Note: Data is from Jan 2012 to Aug 2017. (Source) Ministry of Health, Labour and Welfare

(Year) (Year)

Job vacancy/ seekers ratio (seasonally adjusted)

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

2012 2013 2014 2015 2016 2017

(times)

Number of job vacancy and job seekers (seasonally adjusted)

160

180

200

220

240

260

280

2012 2013 2014 2015 2016 2017

Job vacancyJob seekers

(0000's)

Export volume to Asia (seasonally adjusted, yen billion)

30003100320033003400350036003700380039004000

2010

2011

2012

2013

2014

2015

2016

2017

Note: Data is from Jan 2010 to Sep 2017.(Source) Ministry of Finance, Bank of Japan, compiled by SMAM.

(Year)

Export volume to US (seasonally adjusted, yen billion)

600700800900

100011001200130014001500

2010

2011

2012

2013

2014

2015

2016

2017

Note: Data is from Jan 2010 to Sep 2017.(Source) Ministry of Finance, Bank of Japan, compiled by SMAM.

(Year)

Total export volume (seasonally adjusted, yen billion)

5400560058006000620064006600680070007200

2010

2011

2012

2013

2014

2015

2016

2017

Note: Data is from Jan 2010 to Sep 2017.(Source) Ministry of Finance, Bank of Japan, compiled by SMAM.

(Year)

Strong export growth continues to drive the Japanese economy Drop in export volume in September is going to be temporary due to such as hurricanes in US and a reversal

from extremely strong August results.

7

8

Business sentiment is at a historically high level for both manufacturing & non-manufacturing BOJ “Tankan” business survey in September showed robust business sentiment for both manufacturing and

non-manufacturing companies.

The DI for the current condition was 15 and 14 for manufacturing and non-manufacturing respectively, rising from the previous survey.

-70

-60

-50

-40

-30

-20

-10

0

10

20

All manufacturing

All non-manufacturing

Future condition DI

Currentcondition DI

BOJ "Tankan" business survey

Notes: Data is quarterly from 1Q 2004 to 3Q 2017. DI above 0 means the condition is improving.(Source) Bank of Japan

(Year)

9

Current USD/JPY rate is at a theoretically appropriate level Both in Purchasing Power Parity and real yield differentials, current USD/JPY exchange rate around 110 seems

to be appropriate. Future course will depend on how inflation and interest rates move in both countries.

Japan suffered from deflation for a long time while the rest of the world was more or less having inflation, which drove JPY stronger. However, after BOJ started bold monetary easing in 2013, deflation in Japan stopped and inflation in the rest of the world dramatically declined

96.3125.3

56.1

0

50

100

150

200

250

300

350

400

Actual ratePPI basedCPI basedExport price based

(Year)

USD/JPY rate compared to various Purchasing Power Parity (PPP) adjusted rates

Note: Data is from Mar. 1973 to Aug. 2017(Source) US Department of Labor, US Department of Commerce, FRB, IMF, Ministry of Internal Affairs and Communications, Bloomberg

70

80

90

100

110

120

130

140

▲ 4.0

▲ 3.0

▲ 2.0

▲ 1.0

0.0

1.0

2.0

3.0

03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

10Y real yield differential (left)

USD/JPY (right)

USD/JPY rate and differential of real yields of 10Y government bonds (US-JP) (%) (Yen)

Note: Data is from Jan 31st 2003 to Oct 16th 2017.Real yields are adjusted for CPI ex. food & energy

(Source) US Department of Labor, Ministry of Internal Affairs and Communications, Bloomberg, compiled by SMAM.

(Year)

10

Long bond yields have not headed upward yet despite robust economic growth Despite robust economic growth, long-term bond yields are not rising yet on the back of low inflation.

-0.5

0

0.5

1

1.5

2

2.5

3

3.5US 10Y Germany 10Y Japan 10Y

10 year Government Bond Yield (%)

Note: Weekly data from Jan. 10th, 2014 to Oct. 20th, 2017 (Source) Datastream

(Month/Year)

11

CPI is expected to stay just mildly positive Core CPI, which excludes fresh food, is going to stay mildly positive for the foreseeable future.

Extra-easy monetary policy is going to continue in Japan despite expected tapering in Europe and US.

0.70

-1.4-1.2-1.0-0.8-0.6-0.4-0.20.00.20.40.60.81.01.21.41.61.8

1 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3 4 5 6 7 8 91011121 2 3

2014 2015 2016 2017 2018 2019

Food (excl. fresh food)

Energy

Baseline CPI (excl. food &energy)Core CPI (excl. fresh food)

Nationwide CPI and contribution of components(YoY %)

(Source) Ministry of Internal Affairs & Communications

Forecast by SMAM

Note: Effect of consumption tax hike in April 2014 is excluded.

(Month/Year)

12

The governing coalition parties got credentials from the Japanese people at the general election

PM Abe led governing coalition parties won the lower house election on October 22nd.

Not only securing majority by winning more than 233 seats, LDP and Komeito together maintained more than two thirds (310) of the total seats, which is required for proposing constitutional change. The party of hope and Ishin are also pro-constitutional-change parties, which gets this sensitive agenda more likely to move forward.

Current economic reform as well as extra easy monetary policy will continue, though a lot of political power might be consumed for debating the constitutional change.

LDP Komei Ishin Hope IndependentConstitutional

DemocraticParty

SDP Communist Vacant Total

Oct. 22nd results Total 465 seats

284 29 11 50 22 55 2 12 0 465

Before theelectiontotal 475 seats

284 34 14 57 45 15 2 21 3 475

0 310

Before the electiontotal 475 seats

Oct. 22nd results Total 465 seats

LDP Komei Ishin Hope Independent Constitutional Democratic Party SDP Communist Vacant

(Source) YOMIURI NEWS PAPER

Politics and anticipated tapering by both FRB and ECB could affect financial markets US political battle including the budget for the next fiscal year will intensify heading to the end of CR in

December.

PM Abe has a new credentials from Japanese people now. Constitutional change is going to be the biggest political agenda for PM Abe, meanwhile economic policies need to be pushed forward more aggressively.

13

Schedule of key eventsMonth Region/Country Events Notes

Spain 1 Referendum in Catalonia for independence22 General election Governing coalition won the election.30-31 BOJ Monetary Policy Committee Meeting/ Perspective report

EU 26 ECB policy meeting Start of tapering?China 19th National People's Congress Middle East 30 OPEC meetingUS/Asia US president Trump is expected to visit Asia incl. Japan

12-13 FOMC Rate hike?15 3 month extended CR (temporary government budget) ends Political battle in US congress

Korea 20 Presidential electionNational Diet ordinary session begins22-23 BOJ Monetary Policy Committee Meeting/ Perspective report

February US 3 FRB chair Yellen's term ends Who are the next candidates?March Japan 19 Two deputy governors' term ends April Japan 8 BOJ governor Kuroda's term ends Who is next BOJ governor?(Source) Various publications, assembled by SMAM

Japan

US

Japan

December

2018January

October

November

Outlook for Japanese Stock Markets

14

Stock market outlook: Solid footage on good fundamentals with North Korean risk remains SMAM short-term view After renewing the record of consecutive days of rising, the Japanese stock market is going to have a breather

in the short term. Robust economic and business fundamentals should support the stock prices. The biggest domestic event, general election, is now behind and the focus is back on overseas events such as North Korea and US politics.

Longer-term outlook (6-months and beyond) The global economy is expected to grow in a steady undertone. Earnings for the Japanese companies are

expected to be revised upward, which will provide stimulus to the stock market. Risk factors are such as North Korea situation, possible slowdown in Chinese economy, US budget debate and effects of monetary policy change in EU and US.

Note: SMAM’s projection is as of Oct. 23rd 2017 and subject to updates without notice.

15

700

900

1100

1300

1500

1700

1900

2100

Jan-

15Fe

b-15

Mar

-15

Apr

-15

May

-15

Jun-

15Ju

l-15

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16Fe

b-16

Mar

-16

Apr

-16

May

-16

Jun-

16Ju

l-16

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Dec

-16

Jan-

17Fe

b-17

Mar

-17

Apr

-17

May

-17

Jun-

17Ju

l-17

Aug

-17

Sep

-17

Oct

-17

Nov

-17

Dec

-17

Jan-

18Fe

b-18

Mar

-18

Apr

-18

May

-18

Jun-

18Ju

l-18

Aug

-18

Sep

-18

TOPIXForecast range upsideForecast range downside

TOPIX index forecast range by SMAM

(Source) TOPIX: Tokyo stock exchange, Forecast by SMAM

(Points)

(Month/Year)Note: Topix data is from Jan. 5th 2015 to Oct. 19th 2017.

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views: • Practical Trump trade policies are made and serious trade disputes can be avoided. • US economy keeps growing despite delay in Trump stimulus policies. • Japan’s private consumption to grow mildly supported by wage growth. • Japanese yen does not get extremely stronger beyond 100 yen against US$. • Further fiscal stimulus will be made and extra easy monetary policy should sustain economic growth in

Japan. • Tension in the East Asia does not ignite a war.

Upside Risks include:

• Stronger-than-expected global growth. • Stronger-than-expected measures by the Abe government.

Downside Risks include:

• Confrontational foreign policies taken by Trump presidency shake global trades. • Trump policies for stimulating US economy fail to pass US congress. • “Russia-gate” scandal flares up. • Populism gains in Europe further destabilizing EU. • Heightening geo-political tensions in Middle East & East Asia. • Rekindled concern over emerging economies including China.

16

Note: SMAM’s projection is as of Oct. 23rd 2017 and subject to updates without notice.

17

Japanese stock market made a catch-up move lately meanwhile emerging market leads the league

17

Emerging market continued to rise strongly.

Japanese stock prices in US dollars rose to make a catch-up move to US peers.

708090

100110120130140150 MSCI

EM/US$

S&P500

TOPIX/US$

MSCIEurope/US$

TOPIX/Yen

US$ based performance of stock markets (Dec 2015 =100)

(Source) Datastream, MSCI and Tokyo Stock Exchange, compiled by SMAM.

Notes: Data is up to Oct. 19th 2017.(Month/Year)

Comparing EPS growth and PER, US looks expensive

18

PER rose in September due to rise in share price, meanwhile 12M forward EPS forecast declined after robust EPS growth in 2Q 2017 went behind.

Asia looks attractive with the highest EPS growth and the lowest PER among 4 indices, though risk needs to be put into consideration as well.

US looks expensive. Japan looks more attractive than Europe with higher EPS growth and lower PER, though the difference is not large.

15.03

13.04

18.19

14.31

6

8

10

12

14

16

18

20

PER of MSCI country indices

MSCI Europe MSCI AC Asia ex JP USA Japan

Note: PER is based on 12M forward EPS forecast.Data is up to 30th Sep 2017.

(Source) MSCI

(times)

(DD/MM/YYYY)

9.76

13.3311.19

10.12

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

EPS growth of MSCI country indices

MSCI Europe MSCI AC Asia ex JP USA Japan

Note: Growth is for 12M forward EPS forecast.Data is up to 30th Sep 2017.

(Source) MSCI

(DD/MM/YYYY)

(%)

Foreign investors bought back Japanese shares in October Foreign investors turned to purchasing Japanese shares in October. BOJ’s ETF purchasing has been absent so far in October meanwhile individuals are still selling shares.

19

500

700

900

1100

1300

1500

1700

-2,500

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

Jan Feb Mar Apr May Jun July Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug Sep Oct

Net purchasing of Japanese equities by investor type

Foreign Trust bank Individual Inv. Trust Fund Business corp BOJ ETF TOPIX

TOPIX (points)

Bar charts (Yen billion)

(Source) Japan Exchange Group, Bank of Japan

Note: Data is for Tokyo stock exchange and Nagoya stock exchange up to Oct.13th 2017.BOJ ETF figure is officially released data from BOJ.

2016(Month/Year)

2017

20

Japanese companies are increasing dividends and share buybacks

20

0

10

20

30

40

50

60

70

80

90

100

0

2

4

6

8

10

12

14

16

18

20

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18

(%)(JPY tn) Dividend payments & Share buyback by listed firms

Share Buyback Total（LHS）

Aggregate Dividends（LHS）

Total Shareholders Return（RHS）

Notes : For ordinary shares of listed firms excluding lossmakers or subsidiariesSource : Toyo Keizai, Quick, I-N Information Systems, Daiwa Securities forecasts

(FY)

Forecast

Total of dividend and share buyback amount renewed a historical record in FY2016 and expected to rise further. Total shareholder return, which is the percentage of shareholder earnings returned to shareholders by way of

dividend & share buyback, was 43.5% in FY2016, which is expected to increase just marginally in FY2017 and FY2018.

Increasing shareholder returns lifted ROE to 9.9% in FY 2016

21

ROE rose to 9.9% in FY2016 from 8.5% recorded in FY2015. EPS rose by 18.3%.

After hitting the previous high of 9.5% in FY2013, ROE actually declined due to rapidly accumulating capital despite EPS growth. However, growth of shareholder capital in FY 2016 was controlled at 5.7% owing partly to increasing dividend and share buybacks. Profit margin improvement was also positive for ROE.

0.9%

5.4%

8.2%

9.8%

10.8% 10.8%10.8%

1.8%

4.5%

6.8%

5.0%

6.2%

9.5%8.9%

8.5%

9.9%10.5%

10.3%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

2001

A

2002

A

2003

A

2004

A

2005

A

2006

A

2007

A

2008

A

2009

A

2010

A

2011

A

2012

A

2013

A

2014

A

2015

A

2016

A

2017

E

2018

E

ROE for SMAM research coverage 224 companies

Total 224 (excl. financials)Manufacturing 134Non-manufacturing 90

SMAM forecast

(Fiscal year)Note: Forecast is as of 5th Sep 2017. Displayed numbers are for total companies.(Source) SMAM Corporate Research Group

SMAM forecasts 15% profit growth in FY2017

22

Apr-Jun quarterly earnings were upbeat and SMAM revised FY2017 profit growth forecasts from previous 12.1% to 15.1% in recurring profits.

Forecasts made by companies stay at 7.4%. SMAM is expecting this guidance to be revised upward as the year progresses.

Jul-Sep quarterly earnings results are going to be announced from late October to November.

SMAM Corporate Earnings forecasts (224 Companies research coverage excl. financials)

Fiscal year FY 2015 FY 2016

Date of forecast Actual Actual as of 5th Sep 2017 as of 5th Sep 2017

Revenue (YoY %) 0.7% -3.4% 6.4% 2.1%

Operating Profits (YoY %) 11.8% -1.3% 14.3% 8.2%

Recurring Profits (YoY %) 4.5% 2.1% 15.1% 8.3%Net Profits (YoY %) -0.6% 18.3% 10.1% 7.9%Recurring profits (YoY %)

Manufacturing 134 companies 3.5% -3.5% 16.9% 9.4%

Non-manufacturing 90 companies 6.2% 11.4% 12.5% 6.5%

Self guidance by 224 companies 7.4%Note: Key assumptions for the forecasts for FY 2017, Yen/US$ 110.4, Yen/EUR 128.8 (Source) SMAM Corporate Research Group, Toyo Keizai

FY 2017E FY 2018E

23

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demonstrate capabilities and expertise of Sumitomo Mitsui Asset Management Company, Ltd. (hereinafter “SMAM”), or to provide information on 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.

The expected returns or risks in this report are calculated based upon historical data and/or estimated upon the economic outlook at present, and should be construed no warrant of future returns and risks.

Past performance is not necessarily indicative of future results. The simulated data or returns in this report besides the fund historical returns do not include/reflect any investment management fees,

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