• Bloomberg


Some Japan equity strategists are recommending investors hold off any hunt for bargains until trade tensions cool after the U.S. midterm elections.

A possible decline in protectionist rhetoric once congressional elections end in November may allow investors to focus on Japan’s strong earnings that have been overlooked because of fears of a trade war with the U.S., according to analysts. Japanese stocks have borne the brunt of Asia’s slump because many market participants consider the shares to be cyclical, meaning that global investors tend to sell them first on signs of an economic slump.

“We’re bullish on Japanese stocks as they are extremely cheap in valuation relative to other markets,” said Hiroshi Matsumoto, head of Japan investment at Pictet Asset Management Ltd. in Tokyo. “Real buying may come into Japanese stocks once the market goes through the midterm earnings releases starting in late October and the U.S. interim elections in early November.”

Japan’s Topix index has declined more than 10 percent from its highest in a quarter century in January, while the S&P 500 has gained about 8 percent this year. With the Japanese benchmark gauge falling, its estimated price-to-earnings ratio has dropped 18 percent since the first week of the year, outpacing a 14 percent tumble in valuations for emerging markets.

Jonathan Allum, a strategist at SMBC Nikko Capital Markets Ltd. in London, points out that Japanese stocks have long been considered cyclical assets that are sensitive to global economic sentiment. They are also vulnerable because foreign investors tend to hedge positions by shorting equity futures in Japan, which is the most liquid market in Asia, according to Pictet’s Matsumoto.

“Japan’s underperformance is not wholly unsurprising — even if it is unjustified,” Allum said. “Japanese stocks are cheap and oversold and that may be enough to mean they will outperform if the general investor mood improves.”

For now, investors may find it difficult to buy Japanese stocks as U.S. President Donald Trump renews pressure on the nation to sign a bilateral trade deal. Japan will have a “big problem” if it doesn’t reach a new deal, Trump said.

The threat added to negative sentiment from earlier in the year when surging Treasury yields and prospects of accelerated Federal Reserve tightening roiled global equity markets, dragging the Topix from its 26-year high in January.

“Japan is an easy target for bashing,” said Tetsuro Ii, chief executive officer at Commons Asset Management Inc. in Tokyo. “Europe and other nations carry out reprisals when the U.S. takes action on tariffs, but Japan doesn’t do anything. In that sense, it’s easy for the U.S. to throw a curve ball at Japan before the U.S. midterm elections in November.”

Investors may eventually shift their attention to solid fundamentals as Japanese companies could raise their earnings outlooks after the midterm book-closing ends, according to Ii.

There’s a 30 percent chance that the Nikkei 225 Stock Average may climb above 24,000 by the end of the year, he said.

Martin Malone, a strategist at Mint Partners in London, said the Nikkei 225 has the potential to rise to 26,500 by Dec. 25, partly because the Bank of Japan is unlikely to change its easy monetary policy.

“All Japan macro factors remain in place, with low risk of any tightening of financial conditions, compared with any other region globally,” he said. “The market is super cheap in many ways.”

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