Japanese equity valuations should rise as double-dip concerns fade

- Japanese equity prices excessively discount concerns about global economic outlook: "In our opinion, Japanese equities have excessively priced in concerns about the global economic outlook and a double dip for the Japanese economy. We think this provides an opportunity for investors, particularly value investors with a long-term horizon."
- Little risk of double dip for Japanese economy: "If the Japanese economy were to slide into recession, this would likely be caused by recession in the US or the world economy. We see little risk of the US economy moving into recession unless some kind of major shock occurs. Some argue that the concerted switch to fiscal tightening by major economies could provide a substantial shock. However, our calculations of the impact of policy stimulus withdrawal, as well as past examples of fiscal tightening, indicate that fiscal tightening is unlikely to be so severe as to trigger a recession."
- Japanese economy headed for self-sustained recovery: "We expect the Japanese economy to regain momentum after slowing up to 2011 Q1. We think this momentum will be driven by (1) a rebound in capex, (2) the positive implications of this for employment, incomes and consumption, and (3) firm exports on the back of sustained strong growth in emerging economies."
- Scope for upward adjustment in Japanese equities, which price in fall in FY11 profits: "We think that equity markets price in a scenario whereby the improvement in Japanese corporate earnings loses momentum in the lead-up to FY11, and profits decline in FY11. This suggests to us that market participants may be factoring in a recession for the Japanese economy. Our analysis suggests there is little risk of the Japanese economy sliding into recession. Once the excessive pessimism fades, we think Japanese equities will see an upward adjustment in their low valuations."
- Japanese economy-sensitive stocks at or near lows: "We believe Japanese economy-sensitive (high-beta) stocks are trading at or near lows. As long as there is no recurrence of the financial crisis, we see limited scope for further underperformance by high-beta stocks. Among high-beta stocks, we recommend overweighting sectors sensitive to emerging economies (trading companies, construction machinery). From 2011, we anticipate an almost simultaneous upward adjustment in “capex” and “consumer durables” sectors as well as “domestic demandsensitive” sectors. Meanwhile, valuations look high for "emerging economy growth" sectors (robots/pneumatic equipment, healthcare, cosmetics/toiletries) following strong share price performance in 2010 H1. In the near term, we think "emerging economy-sensitive" sectors could take over as the main driver of high-beta stocks."

Nomura Japan Investment Strategy 20100813

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