Keeping in step with global market moves, the Japanese equity market has been extremely volatile in recent days. The broader benchmark Topix was down by -7.4% in January, and this general market decline accelerated in February as last week ended with a more than -16.5% drop. However, it rebounded sharply today, posting gains of more than +8% in a single day despite the most recent weak macroeconomic data. Released earlier today was data showing real GDP growth for the fourth quarter of 2015 dropping by -0.4% quarter-on-quarter, with an annualised rate of contraction of -1.4%.
We believe this extraordinary volatility has been primarily caused by the shock that has reverberated around the yen/US dollar exchange rate, as the rate moved from 120 yen to the dollar to 112 yen in less than two weeks this month.
This was totally unexpected since the easing approach by the Bank of Japan, which recently adopted a negative interest rate, was expected to prevent the yen from appreciating. However, as concerns over the global economy have grown, the yen has seen investors pile in given it is viewed as a relatively safe currency amidst the risk-off market sentiment.
Even allowing for the possible negative impact of a stronger yen, we expect corporate earnings to be resilient and the market price/earnings ratio is below 13 times, based on 12-month forward earnings. Given the de-rating of most multi-nationals, we believe that the negative impact of the yen strength has been largely discounted in the market with many of them trading below nine times earnings, which would leave a substantial buffer for expected downward revisions.
Furthermore, the positive trend of improving shareholder returns, through higher dividends and share buy-backs, is still intact in our view. As a result, barring a global recession, we believe that the Japanese market is oversold.
The recent sharp market fall has given us opportunities to add to companies that possess strong competitiveness and balance sheets, and we continue to adhere to our strict discipline of investing in quality companies with reasonable valuations.
