In 2013, Japanese markets led the global markets and had their best showing since Japan’s equity bubble burst in 1990. Much of the optimism for Japan’s stock market stems from “Abenomics” policies, which are all aimed at one thing: promoting economic growth in Japan and ending the long-standing deflationary regime that has characterized Japan’s economy and financial markets for the last decade.
I would say the first and second arrows of Abenomics, aggressive monetary and fiscal expansion, have been right on the mark. But can the positive momentum seen in equity prices in 2013 continue into 2014? There are many skeptics of the progress Prime Minister Abe has made on his third arrow—the “growth strategy” of structural reform to the economy and Japan’s markets has languished in early 2014.
While the structural reform will take longer to implement than the first two arrows, I believe investors should take Abe’s word that he is committed to Abenomics and that important changes are in the works. Also, I believe the first two arrows have provided some time for structural reforms to be implemented, because we have already begun to see the start of a “virtuous economic cycle” in the form of higher earnings that is supporting companies raising wages for the first time in many years. Higher wages can then, in turn, support more consumption and better profits, keeping a positive feedback loop.
Continued Separation from Regional Markets
Jonathan Garner1 and his team recently highlighted in a research piece that “Japan is the only regional market where current fiscal year consensus expectations have been raised since the end of last earnings season (November 2013), in contrast with the US, Europe and Emerging Markets.” Mr. Garner and his team were also kind enough to share the chart below, which plots consensus earnings trends over the past year for different regional markets.
Consensus earnings estimates are the average of all the current estimates made available by analysts. Typically, consensus earnings estimates are raised when companies are either increasing profitability or providing positive guidance for future earnings, and lowered in the opposite case.
Figure 1: Consensus Earnings Trend
For definitions of terms in the chart, please visit our Glossary.
• Japan Leads Regional Markets – Based on record government stimulus and yen weakness, it is not surprising that the earnings trend for Japan has been the largest of the above regional markets. What I find most impressive is the fact that the consensus earnings trend continued to rise for Japan even though other regional market earnings were revised downward by about 10% for Europe and 15% for the emerging markets.
• Earnings Have Driven Price-to-Earnings (P/E) Ratio Lower – Japan’s earnings improvement has been so dramatic that the trailing price-to-earnings ratio has actually improved, even after a gain of over 40% for equity markets.2 The only other regional market to see an improvement in its price-to-earnings ratio over the period were the emerging markets, and unfortunately the change was driven by lower prices instead of higher earnings.3
Figure 2: Analysis on Profits, Prices and P/E Ratios
For definitPerioions of terms in the chart, please visit our Glossary.