Amid the wreckage of Japan’s stock market in 2016 lies a surprise: Smaller companies are posting their best relative performance on record.
The Topix Small Index, overlooked by foreign investors and full of companies that make most of their sales within Japan, is near the highest level versus the Topix Core 30 Index of heavyweights in records going back to 1989. While the small-cap gauge is down 8.4 percent this year as a selloff emanating from China ripples through markets around the world, that is less than the broadest Topix index’s 9 percent drop. In the U.S., the opposite is happening: The Russell 2000 Index just entered a bear market and is trading at the lowest relative to the Standard & Poor’s 500 Index in six years.
Japanese investors have reasons to favor smaller companies. China is the nation’s largest trading partner and the yuan fell more against the yen than any other major currency last week, weighing on Tokyo’s giant exporters and leaving stock traders looking for alternatives.
“Small caps are more focused on domestic demand, so they’re less susceptible to influence from abroad. They’re less affected by falls in China and the overseas markets,” Yutaka Miura, a technical analyst at Mizuho Securities Co. in Tokyo, said by phone. “It’s likely that mid- to small-caps will be stronger going forward while the large-cap shares are on a fragile footing.”
NTT Docomo Inc., the best performer this year on the index of Japan’s biggest stocks, is down 1.8 percent. Sakura Internet Inc. led Topix Small gains, more than doubling as it announced it will start providing for free technology that brings private encryption into cloud computing.
The Tokyo Stock Exchange Mothers Index, which includes many small Internet and biotechnology companies, has done even better than the Topix Small, with a decline of 6.9 percent through Thursday as a near-doubling by drugmaker GreenPeptide Co. lifted the gauge.
Small-caps will post double-digit profit growth in the year to March 2017, outpacing larger companies, Mitsubishi UFJ Morgan Stanley Securities Co. analysts wrote in a Jan. 12 report. SMBC Nikko Securities Inc. expects the trend will intensify.
“Outperformance by small/mid-cap stocks on the Japanese market has become more pronounced in recent years,” Ryota Sakagami, chief strategist at SMBC in Tokyo, wrote in a Jan. 8 report. “When we look at the distribution of stocks by average profit growth rates over the past 10 years, we find that a higher proportion of small/mid-caps have recorded major profit growth than large caps.”
Japan’s biggest stocks were the winners after Prime Minister Shinzo Abe came to power in late 2012, promising to revive economic growth through monetary easing and fiscal stimulus. Through a May 2013 peak, the Topix Core index surged 52 percent as the yen tumbled, compared with a 44 percent rally for the Topix Small measure. Since then, small caps have been the better bet. They are up 17 percent, compared with a 1.7 percent advance for the gauge of giant exporters.
CLSA Ltd.’s Nicholas Smith says that’s partly a result of foreign and professional investors dumping their holdings of large companies and not actively looking at the smaller shares.
“When markets initially moved on Abenomics, foreigners bought the Core 30 and then broadened out a bit, but they haven’t really taken much of a look at what’s going on in small or mid-caps,” said Smith, the firm’s Tokyo-based strategist. “If you have the resources to go and poke around with some of the small-cap stocks, you can find some stunning missed value there.”