New growth strategy to lead Nikkei towards 25,000 in 2016

BY YUTAKA UDA

Monthly Fund Commentary
17 Dec 2015

BY YUTAKA UDA

In November, the stock market opened lower against a backdrop of clouded visibility regarding the Chinese economy and diminished expectations for further monetary easing by the BoJ. Thereafter expectations heightened for the Fed to make its first rate hike in December, sending US shares higher and the Nikkei 225 recovered to 19,000 on 5th November.

The market maintained a steady and positive tone throughout the month as (1) earnings in 1H of FY2015 were not as bad as had been feared, (2) US nonfarm payrolls increased by 270,000 MoM in October, much better than market forecast, which weakened the yen, (3) excessive pessimism regarding the Chinese economic outlook faded, and (4) Japan Post’s IPO on 4 November ended successfully. The Nikkei hit 19,994 intraday on 27 November, but failed to break above 20,000 at any point during the month. The terrorist attacks in Paris, on 13 November, did not lead to a significant heightening of the risk-off mood among investors globally. Towards month end, overall trading activity remained subdued in the run-up to December’s major events and the market lost some steam amid increased geopolitical risk and sell-offs in Asian markets.

The Nikkei 225 and the TOPIX ended the month at 19,747.5 (up 3.5% MoM), and 1,580.3 (up 1.4% MoM) respectively. Foreign investors, who had been heavy net sellers in August and September, were net buyers for the fifth consecutive week until the third week of November. The yen started
the month at 120.62 against the US dollar and depreciated to 123.11 towards the end of the month. Among the 33 TSE sectors, the best five performers were metal products, retail, precision instruments, mining and machinery, while the worst five performers were pulp & paper, utilities, air transportation, securities and real estate.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 30 November 2015 rose 0.4% compared with that of 30 October, while the TOPIX went up 1.4% during the same period. The Fund put no new names into the portfolio with no stocks sold out.

The Japanese GDP growth number for 3Q 2015 was revised up to +1.0% QoQ annualised from the preliminary number of -0.8%. Capital expenditure strongly increased from -5.0% to +2.3%. When excluding inventories, final demands would have grown 1.8% QoQ annualised. October’s economic data was quite favourable: Industrial production in October rose 1.4% MoM with shipments up 2.1% MoM and inventories down 1.9% MoM. Retail sales in October increased 1.1% MoM, better than the market consensus of +0.3% MoM, and the jobless ratio declined to 3.1%, the lowest in 20 years and down
from the previous month figure of 3.4%. The production outlook for November (+0.2% MoM) and December (-0.9% MoM) is rather weak. But if Nov-Dec production numbers match the forecast, 4Q 2015 industrial production would rise 1.6% QoQ, up for the first time in three quarters.

In addition to the existing growth strategy and structural reform agenda, the Abe government announced the second stage of Abenomics with three new arrows targeting robust growth. Firstly, the government will try to boost nominal GDP by 22% to JPY600 trillion compared to JPY490 trillion in FY2014 by encouraging capex, realising the benefits of TPP and boosting inbound tourism. Secondly, the government is targeting a raise in the birth rate to 1.8 compared to 1.4 in 2014. Thirdly, it is trying to enhance social security services and financial support for elderly care and to implement healthcare
reforms. As the first step, the government is expected to launch the supplementary budget worth JPY3.3 trillion, which would be approved in the Diet early in 2016. Within a tax reform plan to be decided in December 2015, the government will conclude that the corporate tax rate will be cut to 29.97%
in FY2016 from 32.11% in FY2015 and 34.62% in FY2014. The Investment Adviser strongly believes the Japanese economy will regain strong momentum from 4Q 2015 and should show sustainable high growth for the medium term as a result of this growth strategy. The market should also start to respond to these reformed economic policies. The Nikkei 225 may have a chance of reaching 25,000 by the end of 2016.

Construction and real estate sectors are expected to show another strong rally with replacement demands expanding sharply and 2020 Tokyo Olympics related projects starting. The Fund is increasing allocation to the machinery and IT service sectors with the conviction that capex will have to grow to seek higher productivity. The Fund will also maintain high weightings in banks and commerce (mainly trading companies) sectors. On the other hand, defensive and hardware technology sectors should be avoided as these have high valuations and lower growth potential.

The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Fund as of 11/12/15 and are based on internal research and modelling.