Japanese Stock Market Outlook

SMAM monthly comments & views - November 2016 -

Japanese Economy Recent statistics continue to show mild recovery in the Japanese economy such as industrial production, export volume and sentiment of both businesses and consumers. CPI is expected to remain low, which put pressure on Bank of Japan. Fiscal measures are going to play a major role in stimulating economy going forward, for which low interest rate would provide low borrowing cost for the government. • Japanese exports has been growing led by the recovery in production in Asia, which accounts for more than half of total

exports from Japan. Export recovery to Asia has been broad based. Electrical, chemical, metal goods and machinery are all showing solid recovery.

• 10Y Japanese Government Bond yield once rose to the BOJ’s target of zero percent yield, and then sunk back to the negative territory. Policy shift of BOJ made in September has not produced significant impact on yield curve yet. BOJ’s purchasing pace of JGB has moderated a little.

Japanese Stock Markets The stock market is now going through major key events overseas such as US presidential election. Rising geo-political risks, especially in the Middle East, could still scare the global financial markets in the short term. However, earnings momentum is improving for the Japanese companies and yen seems stabilizing above 100 yen against US dollars, which are supportive for the Japanese stock market. • According IBES, earnings momentum is improving for Japanese companies. Historical EPS keeps recovering since June

and12M forward EPS forecast bottomed in August and moving upwards. Currently, 10.2% of 12M forward EPS growth is forecast.

• Nikkei news paper reported that share buy-backs by listed companies were record high at 4.35 trillion yen between January and September this year compared to the same period in the past. Share buy-backs are continuing at a historically high pace.

Executive summary

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Notes: Macro and market views are as of Oct 17th and 19th , 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

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Recent statistics continue to show mild recovery in the Japanese economy such as industrial production, export volume and sentiment of both businesses and consumers.

CPI is expected to remain low, which put pressure on Bank of Japan. Fiscal measures are going to play a major roll in stimulating economy going forward, for which low interest rate would provide low borrowing cost for the government.

Notes: E=SMAM forecasts. SMAM views are as of Oct. 17th , 2016 and subject to updates thereafter without notice (Source) Cabinet Office, Bank of Japan, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts

(%, YoY except Net Exports)

SMAM economic outlook for FY16-17

( YoY %)

Real GDP growth 0.9% 2.0% -0.9% 0.8% 0.7% 0.7% Private Consumption Expenditure 1.7% 2.3% -2.9% -0.2% 0.5% 0.4% Private Housing Investment 5.7% 8.8% -11.7% 2.4% 4.6% -0.3% Private Capital Investment 0.9% 3.0% 0.1% 2.1% 0.5% 1.0% Public Consumption Expenditure 1.5% 1.6% 0.1% 1.6% 1.6% 1.1% Public Capital Investment 1.0% 10.3% -2.6% -2.7% 2.0% 5.7%Net Exports (contrib. to GDP growth) -0.8% -0.5% 0.6% 0.1% -0.0% 0.0% Exports -1.4% 4.4% 7.9% 0.4% -0.2% 1.6% Imports 3.6% 6.8% 3.4% 0.0% -0.2% 1.8%Nominal GDP 0.0% 1.7% 1.5% 2.2% 0.8% 0.8%GDP Deflator -0.9% -0.3% 2.4% 1.4% 0.0% 0.2%Industrial Production -2.7% 3.0% -0.4% -1.4% 0.7% 2.7%CPI (excl. fresh food) -0.2% 0.8% 0.9% -0.0% -0.3% 0.3%

FY15 FY17EFY12 FY13 FY14 FY16E

4

Baseline CPI is forecast to hover around zero going into the middle of 2017 Core CPI was -0.5% in August and forecast to stay negative until early 2018.

CPI will be dragged down by lingering after effects from yen’s sharp strengthening occurred this year and also YoY fall in energy prices going into the next year.

Even after the contribution of energy price turns positive, CPI is forecast to stay low, which would put pressure on BOJ for further easing.

-1.4-1.2-1.0-0.8-0.6-0.4-0.20.00.20.40.60.81.01.21.41.61.8

1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3

2014 2015 2016 2017 2018

Food (excl. fresh food)

Energy

Baseline CPI (excl. food & energy)

Core CPI (excl. fresh food)

Nationwide CPI and contribution of components(YoY %)

(Source) Ministry of Internal Affairs & Communications

Forecast by SMAM

Note: Effect of consumption tax hike in April 2014 is excluded. (month/year)

5

Policy shift of BOJ has not made significant impact on yield curve yet On 21st of September, BOJ changed the set of its monetary policy to a more sustainable and endurable one.

Target of increasing monetary base at a fixed high pace was withdrawn and controlling target shifted to yield curve, both short-term and long-term interest rates.

10Y Japanese Government Bond yield once rose to the BOJ’s target of zero % yield, and then sunk back to the negative territory. BOJ’s purchasing pace of JGB has moderated a little.

(Source) Bank of Japan

Previous policy New policy NotesQQE with a negativeinterest rate

QQE with yield curve control

Quantitative easing(1) Purchasing of JapaneseGovernment Bonds yen 80 trillion per annum.

Used for controlling the yield of longterm bonds to a target level.

Quantitative easing was changed from a"target itself" to "a tool" for controllingyield curve.

-Purchasing bonds at designated targetprice/yield.

Designated price purchasing is newlyadopted.

Qualitative easingTargeted mixture ofmaturities Abolished

Guidance of average maturity ofpurchasing JGB was abolished.

(2) Purchasing Equity ETF yen 6 trillion per annum yen 6 trillion per annum"Unchanged", but purchases moreTOPIX based ETF shifting from Nikkei225 based ones.

(3) Purchasing REIT yen 90 billion per annum yen 90 billion per annum UnchangedNegative interest rate (4) Negative short term rate -0.1% -0.1% as the current target UnchangedLong term bond yield (5) 10Y JGB yield No clear target Around 0% as the current target New policy

Period for achieving 2%inflation

In around 2 years."Overshooting commitment", whichmeans BOJ continues monetary easinguntil 2% inflation is decisively achieved.

2 years period for achieving 2% inflationwas abandoned.

Inventory / shipment cycle shows the inventory adjustment has completed The chart is supposed to show anticlockwise movement.

YoY Inventory growth started to fall since March 2015 and has reached the final adjustment stage, bottom left part of the chart.

When it crosses the 45 degree line from left to right, the cycle shifts from adjustment phase to expansion phase.

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-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

-8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 8.0

Inventory(YoY %)

Shipment(YoY %)

Apr. 2016

Jan. 2014

Sep. 2014

Inventory / shipment cycle chart for manufacturing industries( 3 months moving average)

(Source) Ministry of Economy, Trade and Industry

Apr. 2015

Aug. 2016

Adjustment phase

Expansion phase

Note: Data period from Jan. 2013 to Aug. 2016

Total export volume is recovering rather strongly led by Asia Japanese exports has been growing led by the recovery in production in Asia, which accounts for more than half

of total exports from Japan.

Export recovery to Asia has been broad based. Electrical, chemical, metal goods and machinery are all showing solid recovery.

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Note: Blue lines are for monthly and red lines are for quarterly data. Data is up to Aug. 2016 and 3Q 2016 data is the average of Jul & Aug. Data is sesonally adjusted by SMAM.(Source) Ministry of Finance, Bank of Japan

600

700

800

900

1000

1100

1200

2010

2011

2012

2013

2014

2015

2016

(yen billion) USA

400450500550600650700750

2010

2011

2012

2013

2014

2015

2016

(yen billion) EU

25002600270028002900300031003200330034003500

2010

2011

2012

2013

2014

2015

2016

Asia(yen billion)

48005000520054005600580060006200

2010

2011

2012

2013

2014

2015

2016

(yen billion) All destinations

Export volume

(year)

(year) (year)

(year)

8

(Source) Cabinet Office

Consumer sentiment has been recovering Economy watchers DI is produced from a survey of people working at jobs sensitive to the condition of

Japanese economy. Current condition DI compares the status at the time of survey with 3 month before, whereas future condition DI shows if future condition in 2 to 3 months is expected to be better or not. DI of 50 is the threshold.

Both DIs have been improving in the recent 4 month from depressed levels and the seasonally adjusted future condition DI has recovered to 49.6, which is almost neutral level.

Note: Data is up to Sep. 2016.

45.6

20

25

30

35

40

45

50

55

60

2010

2011

2012

2013

2014

2015

2016

Seasonally adjusted

Non seasonally adjusted

Economy Watcher DI for current condition

49.6

20253035404550556065

2010

2011

2012

2013

2014

2015

2016

Seasonally adjustedNon seasonally adjusted

Economy Watcher DI for future condition

(year) (year)

Outlook for Japanese Stock Markets

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Stock market outlook: Improving earnings momentum is going to lift the market in the long-term SMAM short-term view The stock market is now going through major key events overseas such as US presidential election. Rising

geo-political risks, especially in the Middle East, could still scare the global financial markets in the short term. However, earnings momentum is improving for the Japanese companies and yen seems stabilizing above 100 yen against US dollars, which are supportive for the Japanese stock market.

Longer-term outlook (6-months and beyond) Risk factors are going to recede gradually and Japanese stock market is expected to try upside supported by

such factors as confirmed recovery in corporate earnings momentum and anticipation for positive effects from public spending. Relative cheapness of stock valuation for Japan should provide support for the stock market.

Note: SMAM’s projection is as of Oct. 19th,, 2016 and subject to updates without notice

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700

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Jan-

14Fe

b-14

Mar

-14

Apr

-14

May

-14

Jun-

14Ju

l-14

Aug

-14

Sep

-14

Oct

-14

Nov

-14

Dec

-14

Jan-

15Fe

b-15

Mar

-15

Apr

-15

May

-15

Jun-

15Ju

l-15

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16Fe

b-16

Mar

-16

Apr

-16

May

-16

Jun-

16Ju

l-16

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Dec

-16

Jan-

17Fe

b-17

Mar

-17

Apr

-17

May

-17

Jun-

17Ju

l-17

Aug

-17

Sep

-17

TOPIXForecast range upsideForecast range downside

TOPIX index forecast range by SMAM

(Source) TOPIX: Tokyo stock exchange, Forecast by SMAM

(Points)

(month/ year)

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views: • Global economy does not enter into a recession. • Japan’s private consumption to grow mildly supported by wage growth. • Japanese corporate earnings growth to gradually recover from the negative shock of stronger yen. • Fiscal stimulus and further monetary easing will be made to sustain economic growth in Japan.

Upside Risks include:

• Stronger-than-expected global growth. • Stronger-than-expected measures by the Abe government.

Downside Risks include:

• Britain’s decision to exit from EU deeply confuses politics and economies in Europe. • Unexpectedly large impact from the process of US monetary policy normalization. • Concern over emerging economies including China. • Falling oil price causes disastrous problem for oil producing countries. • Increasing geopolitical concerns. • Surprise coming from US presidential election.

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SMAM’s forecasts as of October 2016

Business sentiment is holding well this year despite global uncertainties

BOJ makes broad based business survey every quarter and releases its result in early Jan. Apr. Jul. and Oct. Manufacturing sector is showing resilience after the decline in 1Q this year. Recovering industrial production

and export volume are positive factors behind. Despite slight decline in non-manufacturing sector, business sentiment is holding well in Japan.

12

-30

-20

-10

0

10

20

30

1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q F

2010 2011 2012 2013 2014 2015 2016

Large manufacturing enterprises Large non-manufacturing enterprises

Current condition DI

Future condition DI

BOJ "Tankan" business survey, current & future condition DI(*DI above zero indicates the condition is improving)

(Source) Bank of Japan(quarter/ year)

Earnings momentum keeps improving

Earnings momentum is improving for Japanese companies. The blue line in the chart, 12 month trailing EPS or historical EPS keeps recovering since June, and also the red line,12M forward EPS forecast bottomed in August and moving upwards.

10.2% of 12M forward EPS growth is forecast .

13

%

91.6%

100.9%

10.2%

0%

10%

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40%

50%

60%

70%

0

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100

120

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

IBES EPS consensus forecast for TOPIX

Historical EPS (left) 12M Forward EPS forecast (left) 12M forward forecast growth (right)

Note: Up to Oct. 17th, 2016(Source) Datastream, IBES

(Points)

(month/ year)

PER is in the lower half of the range for the current PM Abe’s tenure

Since Abenomics started, PER for Japanese stock market, TOPIX index-wise, has been in a range between 12x and 16x except for temporary overshooting.

As of October 14th, PER for TOPX was 13.35x whereas comparative PER for S&P 500 was over 17x. Relative valuation of Japanese stocks looks attractive compared to US stocks.

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300

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Jan-

07M

ar-0

7M

ay-0

7Ju

l-07

Sep

-07

Nov

-07

Jan-

08M

ar-0

8M

ay-0

8Ju

l-08

Sep

-08

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-08

Jan-

09M

ar-0

9M

ay-0

9Ju

l-09

Sep

-09

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-09

Jan-

10M

ar-1

0M

ay-1

0Ju

l-10

Sep

-10

Nov

-10

Jan-

11M

ar-1

1M

ay-1

1Ju

l-11

Sep

-11

Nov

-11

Jan-

12M

ar-1

2M

ay-1

2Ju

l-12

Sep

-12

Nov

-12

Jan-

13M

ar-1

3M

ay-1

3Ju

l-13

Sep

-13

Nov

-13

Jan-

14M

ar-1

4M

ay-1

4Ju

l-14

Sep

-14

Nov

-14

Jan-

15M

ar-1

5M

ay-1

5Ju

l-15

Sep

-15

Nov

-15

Jan-

16M

ar-1

6M

ay-1

6Ju

l-16

Sep

-16

Notes: TOPIX: calender year and week-end, P/E ratio is based on 12-month forward EPS of IBESSource: TOPIX: Tokyo Stock Exchange, 12 month forward EPS of IBES: SMAM

TOPIX

Data is up to Oct. 14th 2016 when TOPIX was 1347.19

TOPIX and PER based on 12-month forward EPS

16x

12x13x14x15x

PM Abe's 2nd term started

(month/ year)

(points)

Notes: Topix: calendar year and week-end, P/E ratio is based on –month forward EPS of IBES. Data is up to Oct 14th, 2016 when TOPIX was 1347.19 (Source) TOPIX: Tokyo Stock Exchange, 12month forward EPS of IBES: SMAM

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96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

(%)(JPY tn) Dividend payments & Share buyback by listed firms

Share Buyback Total（LHS）

Aggregate Dividends（LHS）

Total Shareholders Return（RHS）

Notes : For ordinary shares of listed firms excluding lossmakers or subsidiariesSource : Toyo Keizai, Quick, I-N Information Systems, Daiwa Securities forecasts As of Aug. 18th 2016

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Total shareholders return is forecast to increase in FY 2016 and 2017

15

Nikkei news paper reported that share buy-backs by listed companies were record high at 4.35 trillion yen between January and September this year compared to the same period in the past. Share buy-backs are continuing at a historically high pace.

Total shareholder return ratio is forecast to exceed 50% in FY2016, the first time since early 2000’s except for in 2008 when sharp decline in earnings temporarily spiked the ratio.

Forecast

(FY)

Foreign investors selling stopped in October Japanese stock markets faced a continuing selling by foreign investors in September, which seems to have

halted in early October. Trust banks were not net buyers in September, however, this is supposed to be an exception as BOJ’s

purchasing of ETF should continue.

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500

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1500

1700

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Aug Sep Oct

Net purchasing of Japanese equities by investor type

Foreign Trust bank Individual Inv. Trust Fund Business corp TOPIX

2015

TOPIX (points)

Bar charts (Yen billion)

(Source) Japan Exchange GroupNote: Data is for Tokyo stock exchange and Nagoya stock exchange Up to Oct. 7th 2016

2016 (month/ year)

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