Japanese Stock Market Outlook

SMAM monthly comments & views - August 2015 -

Japanese Economy

Japan’s economic recovery is on track, as robust Exports and Industrial Production lead the moderate growth. Meantime, faltering Consumption is likely to recover on higher nominal wages gain.

• SMAM cut real GDP forecast from +1.6% to +1.5% in FY2015 and from +1.9% to +1.8% in FY2016.

• Exports and Industrial Production in April-June are expected to grow at slower pace, and accelerate from 2H

2015 alongside moderate global recovery.

• Private Consumption data shows still soggy, however Consumption will accelerate from July-September led by

higher nominal wages growth.

• SMAM raised Core-CPI forecast from +0.2% to +0.3% for FY2015 and maintained at +1.1% for 2016, which is

far below the inflation forecast by BOJ (+0.7% for FY2015 and +1.9% for FY2016), but the bank is less likely to

move to additional easing.

Japanese Stock Markets

Current stocks are fairly valued on upbeat corporate earnings. There would be still some room for upward revision in profit forecast based on current currency rates.

• FY2015 corporate profits are expected to be revised upward due to weak JPY.

• Overseas investors were accumulating Japanese equities.

• Downside risk is associated with foreign factors such as geopolitical concerns, uncertainties surrounding

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

Executive summary

1

Notes: Macro and market views are as of July 16th and 22th, 2015 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

SMAM cut real GDP forecast from +1.6% to +1.5% for FY2015 and from +1.9% to +1.8% for FY2016.

Net Exports forecast for FY2015 were revised downward from +0.3ppt to +0.2ppt on weak Exports in April-

June quarter. Industrial Production forecasts were also downgraded from +2.3% to +0.7% for FY2015 and from

+3.7% to +3.5% for FY2016.

Notes: E=SMAM forecasts. SMAM views are as of July 16th, 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 FY15-16

Real GDP growth 1.0% 2.1% -0.9% 1.5% 1.8%

Private Consumption Expenditure 1.8% 2.5% -3.1% 1.4% 2.0%

Private Housing Investment 5.7% 9.3% -11.7% 1.3% 4.4%

Private Capital Investment 1.2% 4.0% 0.4% 3.5% 3.2%

Public Consumption Expenditure 1.5% 1.6% 0.4% 0.7% 0.5%

Public Capital Investment 1.0% 10.3% 2.0% -3.3% -1.6%

Net Exports (contrib. to GDP growth) -0.8% -0.5% 0.6% 0.2% 0.1%

Exports -1.4% 4.4% 8.0% 5.4% 5.0%

Imports 3.6% 6.7% 3.7% 4.9% 5.2%

Nominal GDP 0.1% 1.8% 1.6% 2.2% 2.4%

GDP Deflator -0.9% -0.3% 2.5% 0.8% 0.5%FY s tarting Apri l and ending March

FY12 FY13 FY14 FY16EFY15E

Quarterly GDP: Mid-to-high-1% growth after a strong growth in January-March

SMAM revised real GDP forecast downward from +0.8% to +0.5% for April-June.

The economy is likely to stay soft in April-June after the strong growth in January-March. SMAM expects the

economy to keep a mid-to-high-1% growth after a temporary softening in April-June on solid domestic demands

and recovery of Exports. Industry Production and Exports will recover from July-September led by US growth as

ISM data in US has been improving.

4

Notes: E=SMAM forecasts. SMAM views are as of July 16th, 2015 and subject to updates thereafter without notice Source: Cabinet Office, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts . The above data is as of July 16th, 2015. .

4.4

-6.8

-2.0

1.2

3.9

0.51.5 1.8 1.7 1.7 1.7 2.2 2.8

-25

-20

-15

-10

-5

0

5

10

15

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

14 15 16 17

Government Capital Investment

Government Expenditures

Private Consumption Expenditures

Private Housing Investment

Private capital Investment

Private Inventory Increases

Net Exports

Real GDP

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

(Source) Cabinet Office, SMAM forecast

Forecast by SMAM

5

SMAM forecasts current recovery process in order from Exports to Production and Consumption. The ongoing

recovery is at the final stage of Consumption.

Exports and Industrial Production continue stable growth, and Consumption is eventually picking up.

April-June three data (IP, Exports and Consumption) show a respite in recovery.

SMAM expects Private Consumption Expenditures to recover from July-September quarter although current

consumption data remain weak. Wealth effect by rising stock prices and real wages growth will push the

Consumption higher.

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 2Q

12 13 14 15

Exports

Industrial Production

Consumption Expenditures

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

(Source) Ministry of Economy, Trade and Industry, BOJ, Cabinet Office, SMAM seasonally adjusted*1: Industrial Production for 2Q 2015 i s estimated based on the data of Industrial Production Forecast Index.

Forecast by SMAM

Wages: Basic Wages keep growing

Basic wages continue increasing at a moderate pace. Pay scale increase by “Shunto negotiation” accelerate the

wages growth from June.

SMAM expects Basic wages to grow at +0.7% YoY and total nominal wages to grow +1.1% in FY2015.

6

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

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

07 08 09 10 11 12 13 14 15

Employers, more than 5 employees

Basic Wage growth(%, YoY)

(Source) Ministry of Health, Labour and Welfare, SMAM

0.0

1.0

2.0

3.0

4.0

5.0

6.0-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Basic wages growth (LHS)

Pay scale increase (LHS)

Unemployment rate (RHS)

(Basic wages growth, Pay scale increase, %)

Basic wages growth (YoY), Pay scale increase (YoY) and Unemployment rate

SMAM Forcast

(Unemployment rate, %)

(Source) Ministry of Health, Labour and Welfare, SMAM (Up to 2016)

Wages: Pay increase will push incomes higher

Wages are expected to continue growing as job market remains tight and labor resource remains limited to grow.

Wages gain will push up incomes and this will support Private Consumption Expenditures (PCE) to recover.

SMAM expects PCE to contribute to the GDP growth largely in FY2015 and 2016.

7

-2%

-1%

0%

1%

2%

3%

4%

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 2 3 4 5

12 13 14 15

Contribution by Labor Popuration （3month MA）

Contribution by Total Cash Earnings (3month MA, YoY）

Total Cash Earnings Growth (monthly, YoY)

Total Cash Earnings Growth (3month MA, YoY)

(Note) Data of thelatest quarter is based on average of data for latest months.

(Source) Ministry of Health, Labour and Welfare, SMAM

Wages Growth and Labor Popuration Growth (YoY)(YoY)

Forecast by SMAM

-2.0

1.2

3.9

0.5

1.51.8 1.7

-4

-3

-2

-1

0

1

2

3

4

5

6

3 4 1 2 3 4 1

15 16

Private Consumption Expenditures

Private Housing Investment

Private capital Investment

Others

Net Exports

Real GDP

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

(Source) Cabinet Office, SMAM forecast

Forecast by SMAM

Private Consumption: Anemic Private Consumption in April-June

Private consumption data on a 3 month MA basis showed anemic recovery until April-June. Private

Consumption Index, Household Survey and Retail Sales in April-June lost 0.5%, 2.4% and 0.7% respectively.

However SMAM expects PCE to maintain +0.2% growth in April-June with a recovery in month by month (see

next page).

8

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

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

10 11 12 13 14 15

Private Consumption Index

Survey of Household Economy （after household # adjusted）

Retail Sales (Real)

Real Privete Consumption of ＧDP Data

(Note) Data of thelatest quarter is based on average of data for latest months.(Source) Cabinet Office, Ministry of Economy, Trade and Industry, SMAM

Private Consumption Data (3 month MA basis, YoY)

9

Private Consumption: Monthly data show “Recovery”

Monthly PCE data shows a sign of recovery. Both of Private Consumption Index and Retail sales rose in May.

New Car Sales have been bottoming out since January. SMAM expects PCE to resume growing at faster pace

from July-September.

-40%

-20%

0%

20%

40%

60%

80%

100%

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 2 3 4 5 6

12 13 14 15

Mini Cars

Passenger Cars (mid-large)

New Car Sales

New Car Sales

(Source) Japan Automobile Dealers Association, Japan Mini Vehicles Association , SMAM

(YoY, %)

90

95

100

105

110

115

120

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 2 3 4 5

12 13 14 15

Index

Private Consumption Index

Retail Sales Index (Real)

(Note) Data of thelatest quarter is based on average of data for latest months.(Source) Cabinet Office, Ministry of Economy, Trade and Industry, SMAM

Private Consumption Data (Monthly, YoY)

Outlook for Japanese Stock Markets

10

Stock market outlook: Earnings growth prospects should help the stock market

SMAM short-term view

In addition to moderate growth in Production and Exports, Consumption recovery would lift the macro

economy. Corporate earnings are expected to continue double digit growth in FY2015.

The stock market is expected to keep advancing as Japan's reflation policy is very likely to continue until next

consumption tax hike in 2017. Increasing expectation for dovish US rate hike should also support the market.

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

growth, solid corporate earnings and strengthened reflationary policies in Japan. Investors are more likely to focus on earnings upward revision after April-June company reports.

Note: SMAM’s Projection is as of July 22th, 2015 and subject to updates without notice

11

500

700

900

1,100

1,300

1,500

1,700

1,900

2,100

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 Apr-16 Jul-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)

Upto September 2016

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 higher real wages growth

• 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

TOPIX / EPS forecast: Fairly valued on upbeat forward EPS

IBES consensus EPS continues rising supported by solid growth prospects. IBES 12 month and 18 month

forward EPS are JPY107.7 and JPY112.6 respectively, while TOPIX EPS is currently JPY93.2 as of July 17th.

TOPIX of 1,662.94 as of July 17th seems fairly valued as the current P/Es are 14.7x and 15.4x based on the

IBES 18 month and 12 month forward EPS forecasts.

13

-20

0

20

40

60

80

100

120

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2003/12 2004/12 2005/12 2006/12 2007/12 2008/12 2009/12 2010/12 2011/12 2012/12 2013/12 2014/12 2015/12 2016/12

(TOPIX, point)TOPIX and Forward EPS Forecast

TOPIX (LHS)

IBES Consensus EPS (RHS)

(Source) Bloomberg, DataStream, SMAM

Consensus EstimateHistorical EPS

(EPS, JPY)

12M FWD EPS=107.7

18M FWD EPS=112.6

as of July 17th 2015

Upto January 2017

TOPIX EPS=93.2

Corporate earnings : SMAM forecasting upbeat earnings growth

For FY2016, the recurring profits are expected to continue to grow by +8.5% YoY for SMAM core research

universe (216 companies).

Provided the recurring profits for FY2007 are set at 100, the profits are expected to keep growing to 122 and

133 for FY2015 and FY2016 after renewing the record highs in FY2014.

14

47

60

72

84

94100

4247

75

63

72

98103

122

133

5

10

15

20

25

30

35

40

FY20

02

FY20

03

FY20

04

FY20

05

FY20

06

FY20

07

FY20

08

FY20

09

FY20

10

FY20

11

FY20

12

FY20

13

FY20

14

FY20

15

E

FY20

16

E

(JPY Tri l lion)

(Note) 2007=100(Source) SMAM

SMAM Core-Research Universe Recurning Profits, 2007=100

Total (exc. Financials)

Manufacturers

Non-Manufactureres （Financials）

Supply-Demand balance ①: Public pensions raising Japanese stocks

Three large pensions such as Central Government Employees Retirement Fund (KKR), Local Government

Employees Retirement Funds and Private School Employees Retirement Funds are raising Japanese equities,

following the largest pension of GPIF.

All four pensions are estimated to buy another JPY5.3 trillion if they increase Japanese equities to 25% weight

in the portfolios.

15

Total Japanese BondsJapanese

EquitiesForeign Bonds Foreign Equities Others

GPIF 100.0% 38.4% 23.0% 12.5% 21.1% 5.0%

Centra l Government Employees Reti rement Fund (KKR) 100.0% 72.2% 10.3% 1.4% 1.4% 6.0%

Local Government Employees Reti rement Funds 100.0% 49.7% 22.5% 11.3% 11.3% 1.3%

Private School Employees Reti rement Funds 100.0% 52.8% 12.5% 12.2% 12.2% 9.7%

Average 100.0% 41.6% 22.1% 11.9% 11.9% 4.7%

*Target a l location weight (estimated) 100.0% 35.0% 25.0% 15.0% 25.0% 0.0%(Source) GPIF, Central Government Employees Retirement Fund (KKR), Local Government Employees Retirement ＦｕｎｄｓＰｒｉｖａｔｅ and School Emploees Retirement Funds and Nomura estimated(Note) The above estimates are subject to updates thereafter without notice.

Asset Al location

al location weight/tota l portfol io (%) as of June 2015

0%

10%

20%

30%

40%

50%

60%

70%

80%

Japanese Bonds Japanese Equities Foreign Bonds Foreign Equities Others

GPIF

Central Government Employees Retirement Fund (KKR)

Local Government Employees Retirement Funds

Private School Employees Retirement Funds

25%

Supply-Demand balance②: Domestic investors raised positions on weakness

Overseas investors temporarily liquidated Nikkei futures positions for the 1st and 2nd week of July when Nikkei

Index dropped to below 20,000 on a plunge in Chinese stocks. The net sale for futures increased to JPY1,186

billion, whereas that for cash positions remained relatively stable at JPY682 billion in net sale.

Meantime, domestic investors raised Japanese stocks on weakness in market. Mutual funds and retail investors

bought JPY854 billion and JPY796 billion respectively during the same period.

16

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

7,000

9,000

11,000

13,000

15,000

17,000

19,000

21,000

23,000

04/12 05/06 05/12 06/06 06/12 07/06 07/12 08/06 08/12 09/06 09/12 10/06 10/12 11/06 11/12 12/06 12/12 13/06 13/12 14/06 14/12 15/06

Foreign Investors Net Purchase of Cash Equities (cumulative)

Nikkei 225 (LHS) Net Purchase of Cash Equities (RHS)

Upto July 10th 2015(Source) Tokyo Stock Exchange, SMAM

(Yen) (JPY bi l lion)

▲ 2,000

▲ 1,500

▲ 1,000

▲ 500

0

500

1,000

Overseas Financials Corporate Mutual Funds Retail

(Transaction value, JPY billion)

(Source) Tokyo Stock Exchange, SMAM

Transaction Value (futures/cash) by investor category

1st week July

1nd week July

17

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