Japanese Stock Market Outlook

SMAM monthly comments & views - May 2016 -

Japanese Economy

Large fiscal spending is now expected for FY 2016 and 2017. Forecast for Public Capital Investment was raised from -2.9% to +1.4% for FY 2016 and from +0.3% to +4.0% for FY2017. GDP forecast for FY2017 was lifted from -0.2% to +0.2%.

• Recent earthquake in Kumamoto, Kyushu will pull down private consumption for Apr-Jun to some extent. A series of

earthquake has not completely stopped yet and some factories were hit, however, the damage to the Japanese

economy is not going to be as large as the case in the past such as Hanshin-awaji in 1995 and East Japan in 2011.

• Important political events are scheduled in the first half of this year. A G7 meeting is held in May in Ise-Shima Japan.

PM Abe is keen to make it successful running up to an Upper House election in July. Fiscal stimulus is going to be a

major issue.

Japanese Stock Markets

As well as the large fiscal spending now expected, BOJ is likely to make further easing by June in our main scenario. Such stimulus measures are expected to gradually lift Japanese economy and investors sentiments.

• Conservative earnings guidance by Japanese companies are expected for FY2016 when they announce FY2015

results in May, which could cap the upside for the stock market for the short term.

• Chinese economy seems reviving some and US economy seems gathering strength. If this recovering trend continues,

hard hit external demand related stocks have a chance for revival, which could lead the Japanese stock market into a

upward path again.

Executive summary

1

Notes: Macro and market views are as of Apr.14th and 18th 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

Large fiscal spending is now expected for FY 2016 and 2017. Forecast for Public Capital Investment was

raised from -2.9% to +1.4% for FY 2016 and from +0.3% to +4.0% for FY2017. GDP forecast for FY2017 was

lifted from -0.2% to +0.2%.

Current forecast assumes consumption tax to rise from 8% to 10% in April 2017 as scheduled. Odds for

postponing this tax hike is rising and if it is postponed GDP forecast will be +0.6% for FY2016 and +0.8% for

FY2017.

Notes: E=SMAM forecasts. SMAM views are as of Apr. 14thand 18th , 2016 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 FY15-17

Real GDP growth 0.9% 2.0% -1.0% 0.7% 0.8% 0.2%

Private Consumption Expenditure 1.7% 2.3% -2.9% -0.5% 0.8% -0.3%

Private Housing Investment 5.7% 8.8% -11.7% 2.3% 2.7% -3.9%

Private Capital Investment 0.9% 3.0% 0.1% 2.2% 2.2% -1.3%

Public Consumption Expenditure 1.5% 1.6% 0.1% 1.4% 1.0% 0.8%

Public Capital Investment 1.0% 10.3% -2.6% -1.8% 1.4% 4.0%

Net Exports (contrib. to GDP growth) -0.8% -0.5% 0.6% 0.1% 0.0% 0.3%

Exports -1.4% 4.4% 7.8% 0.6% 2.6% 3.0%

Imports 3.6% 6.7% 3.3% 0.1% 3.0% 1.8%

Nominal GDP 0.0% 1.7% 1.5% 2.0% 0.4% 1.4%

GDP Deflator -0.9% -0.3% 2.5% 1.3% -0.4% 1.2%

FY15E FY17EFY12 FY13 FY14 FY16E

4

Recent earthquake in Kumamoto, Kyushu will pull down private consumption for Apr-Jun to some extent. A

series of earthquake has not completely stopped yet and some factories were hit, however, the damage to the

Japanese economy is not going to be as large as the case in the past such as Hanshin-awaji in 1995 and East

Japan in 2011.

Private consumption is forecast to make recovery from Jul-Sep quarter. A rush demand before consumption tax

hike and its reversal contraction are currently included in our forecast for 2017.

SMAM quarterly economic outlook

Notes: SMAM views are as of Apr.14th,and 18th ,2016 and subject to updates thereafter without notice. Source: Cabinet Office, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts .

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13Q1 Q2 Q3 Q4 14Q1 Q2 Q3 Q4 15Q1 Q2 Q3 Q4 16Q1 Q2 Q3 Q4 17Q1 Q2

Private Consumption

Private Housing Investment

Private Capital Investment

Public Investment

Others

Net Export

Real GDP

Forecast by SMAM

(QoQ % annualized) Real GDP and contribution by components

Total export volume is not deteriorating despite sluggishness to China and Asia

Export volume from Japan is not deteriorating despite weakness to China and Asia.

Latest strength in export to EU might be exceptional, however, exports to EU and USA has been rather solid so

far.

5

Note: Blue lines are for monthly and red lines are for quartrerly data.

(Source) Ministry of Finance, Bank of Japan

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2010

2011

2012

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2016

(yen billion) USA

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550

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650

700

750

2010

2011

2012

2013

2014

2015

2016

(yen billion) EU

700

800

900

1000

1100

1200

1300

1400

2010

2011

2012

2013

2014

2015

2016

China(yen billion)

4800

5000

5200

5400

5600

5800

6000

6200

2010

2011

2012

2013

2014

2015

2016

(yen billion) All destinations

Export volume

6

Trade balance is recovering as Japanese economy feels full benefit from low energy cost

Trade balance is recovering and expected to stay in positive territory. Current balance is also recovering to the

historically high level.

This is a double edged sword for the economy and stock market. This positive balance shows relative strength

of the Japanese industries and national finance ,however, it could also mean the fundamental economic force

for weaker yen is receding, though flow of capital is also important for the direction of currencies.

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18

Trade balance

Current balance

Forecast by SMAM

Trade balance & Current balance as % of GDP

(Source) Ministry of Finance, Bank of Japan

7

Increase in number of employees is driving the growth in aggregated real income

The spring wage negotiation “Shunto” this year was a little disappointing due to a growing cautiousness on

corporate profits, which could weigh on the private consumption.

If you look at it from a different angle, however, aggregated real income has been increasing rather solidly

driven by increase in number of employees.

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-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

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2012 2013 2014 2015 2016

Nominal wage Number of employees Inflation Aggregated employees real income

(Source) Ministry of Health, Labor and Welfare

(%)

Aggregated employees' real income and contribution by components (YoY%)

8

Core CPI is forecast to dip into negative territory in mid 2016

Core CPI, which excludes fresh food, is forecast to fall into negative numbers in the mid 2016.

CPI watched by BOJ, which excludes fresh food & energy, was unchanged at 1.1% in February, however, the

momentum seems declining and further easing from BOJ is expected this year.

0.00

-0.91

1.1

-1.4

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-0.8

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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

2013 2014 2015 2016 2017

CPI and contribution by main components(YoY %)

(Source) Ministry of Internal Affairs & Communications, forecast by SMAM.

Forecast by SMAM

Core CPI(excl. fresh food)

Food(excl. fresh food)

Energy

CPI watched by BOJ(excl. fresh food & energy)

Note: Excluding direct impact from consumption tax hike in April 2014.

Outlook for Japanese Stock Markets

9

Stock market outlook: waiting for fiscal stimulus measures and global economic recovery

SMAM short-term view Conservative earnings guidance by Japanese companies are expected for FY2016 when they announce

FY2015 results in May, which could cap the upside for the stock market for the short term.

Longer-term outlook (6-months and beyond) Large fiscal spending is now forecast in Japan. BOJ is expected to make further easing by June in our main

scenario. Such stimulus measures are expected to gradually lift Japanese economy and investors sentiments. Chinese economy seems reviving some and US economy seems gathering strength. If this recovering trend

continues, hardly hit external demand related stocks have a chance for revival, which could lead the Japanese stock market into a upward path again.

Note: SMAM’s Projection is as of Apr. 18th 2016 and subject to updates without notice

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TOPIX

Forecast range upside

Forecast range downside

TOPIX index forecast range by SMAM

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

(Points)

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views:

• Global economy does not enter into a recession.

• Japan’s private consumption to grow mildly supported by wage growth.

• Japanese corporate earnings keep growing at higher pace than in peer countries.

• 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:

• Unexpectedly large impact from the process of US monetary policy normalization.

• Concern over emerging economies including China.

• Falling oil price causes disastrous problem for oil producing countries.

• Increasing geopolitical concerns.

11

12

The chart below tracks the earnings planning by large enterprises released in BOJ Tankan quarterly

business survey. YoY negative growth of -2.0% was planned for FY2016 in March survey.

As a usual practice, Japanese companies started planning conservatively and revised it upward except

in FY2008 and 2009 affected by financial crisis and FY 2011 hit by East Japan Earthquake and

Tsunami.

Earnings planning for the fiscal year 2016 started conservatively just as a usual practice

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Change in earnings forecasts by companies for each fiscal year,BOJ TANKAN Business survey , large enterprises

(YoY %)

Survey in March 2016

(Source) Bank of Japan

Note: For each year, data is survey in March, June, September ,December followed bythe last estimate and actual result.

13

According to IBES consensus estimate, historical earnings have been revised downward recently and

1Y forward earnings forecast by analysts is likely to follow downward for a while.

SMAM covers 216 companies excluding financials for regular researches and forecasts recurring

profits to grow 7.6% for FY 2015 ending in March and 5.6% for FY 2016 assuming 115 yen/$ rate.

Companies will announce own forecasts for FY 2016 around in May. If yen/$ stays around current level

below 110, companies’ earnings guidance for FY 2016 could be conservative.

Historical earnings are revised downward and forward earnings forecast to follow

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11/03 12/03 13/03 14/03 15/03 16/03

IBES EPS consensus forecast for TOPIX

Historical EPS (left) 12M Forward EPS forecast (left) 12M forward forecast growth (right)

Up to Apr. 14th, 2016(Source) Datastream, IBES

(Points)

PER is in the lower half of the range for the current PM Abe’s tenure

Since Abenomics started, PER for Japanese stock market, in TOPIX index, has been in a range between 12x

and 16x except for temporary overshooting.

Even considering further down-revision in earnings, current PER doesn't look expensive.

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Notes: TOPIX: calender year and week-end, P/E ratio is based on 12-month forward EPS of IBESSource: TOPIX: Tokyo Stock Exchange, 12 month forward EPS of IBES: SMAM

TOPIX

Data is up to Apr.15th 2016 when TOPIX was 1361.40

TOPIX and PER based on 12-month forward EPS

16x

12x

13x

14x

15xPM Abe's 2nd term started

Foreign investors are selling and pension funds are buying

Foreign investors continue to sell Japanese equities whereas trust banks, mostly representing pension funds,

are the largest purchaser.

Foreign investors’ selling eased in April, however, they sold 176 billion yen of exchange traded futures in the

week between April 4th and 8th.

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

Net purchasing of Japanese equities by investor type

Foreign Trust bank Individual Inv. Trust Fund Business corp TOPIX

2015

TOPIX (points)

Bar charts (Yen billion)

(Source) Japan Exchange Group

Note: Data is for Tokyo stock exchange and Nagoya stock exchangeData for Apr. 2016 is from Apr. 4th to Apr. 8th. Up to Apr. 8th 2016

2016

Political events hold the key for the outlook of Japanese economy and stock markets

Important political events are scheduled in the first half of this year.

A G7 meeting is held in May in Ise-Shima Japan. PM Abe is keen to make it successful running up to an Upper

House election in July.

Fiscal stimulus is going to be a major issue.

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Obuchi

Mori

Koizumi

Abe 1

Fukuda

Aso

Hatoyama

Kan

Noda

Abe 2

Approval ratings of Japanese cabinets by Prime Ministers(%)

(Source) NHK

Apr. 43%

Aug. 37%

Current Abe

Could negative interest rate cause shift in huge household assets in Japan?

In Japan, as much as 53% of huge household assets are held in cash and deposits with minimal yields.

Interest rate for individuals would not become negative yet due to the guidance by the government to financial

institutions, however, individuals might start looking for more yield for their assets.

On the other hand, if negative interest rate confuses financial systems and uncertainty deepens, individuals

could be discouraged to take risks for their savings.

17

53%

14%

34%

2%

5%

4%

5%

13%

9%

10%

34%

17%

26%

32%

33%

4%

3%

3%

0% 20% 40% 60% 80% 100%

Japan

Unites States

Euro area

Currrency & deposites Bonds Investment trusts

Shares & equities Insurance & pension reserves Others

Household financial assets breakdown

Note: Data for Japan & US is Sep. 2015 and for Euro area, Jun. 2015.(Source) Bank of Japan

Total1,684 trillion yen

Total68.9 trillion dollars

Total21.7 trillion euro

18

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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.

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transaction costs, or re-balancing costs, etc. = The investment products or strategies do not guarantee future results nor guarantee the principal of investments. The investments may suffer

losses and the results of investments, including such losses, belong to the client. = The recipient of this report must make its own independent decisions regarding investments. = The opinions, outlooks and estimates in this report do not guarantee future trends or results. They constitute SMAM’s judgment as of the date of

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