Japanese Stock Market Outlook

SMAM monthly comments & views - July 2017 -

Japanese Economy Order taking of public construction spending has picked up lately, which is forecast to feed through to the actual spending with 2 to 3 months lag. Increase in Public Capital Investment and Private Capital Investment as well as steady growth of Private Consumption will drive the Japanese economy. • Private consumption for durable goods seems to be increasing. Renewal demands might be appearing for TV sets, Cars and

others purchased on government incentives just after the global financial crisis. • Approval rating for the Abe cabinet fell from 53% to 48% in June. Disapproval rating jumped from 30% to 36%. Tokyo

Metropolitan Assembly election is held on 2nd of July. The party “Tomin 1st”, lead by the popular Governor Yuriko Koike, will gain many seats. If Democratic Party of Japan loses too many seats, the trouble for PM Abe could deepen further.

Japanese Stock Markets Japanese stock market might test the upside led by US stock market. Relatively attractive stock valuation compared to US is a positive factor. Possibility of global risk events blowing out has receded at least for now. Continuing expansion of global economy and corporate earnings would support the Japanese stock market in the long term. • Based on 12M forward EPS of 112, TOPIX PER is calculated at just above 14x. PER for MSCI US index is 18x and for MSCI

Europe is 15x, which makes Japanese stock market look attractive in global comparison . • Major risks are such as historically high stock valuation for US markets, deterioration of PM Abe’s political power, geo-

political risk in East Asia and confusion in US politics.

Executive summary

1

Notes: Macro and market views are as of Jun. 16th and 20th , 2017 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

GDP for FY2016 was changed from 1.3% to 1.2% due to the Jan-Mar 2017 GDP revised down from first preliminary 1.9% to second-preliminary 1.0%, meanwhile the forecasts for FY2017 and FY2018 were maintained.

Increase in Public Capital Investment and Private Capital Investment as well as steady growth of Private Consumption will drive the Japanese economy.

Notes: E=SMAM forecasts. SMAM views are as of Jun. 16th , 2017 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 FY17-18

( YoY %)

Real GDP growth 2.6% -0.5% 1.2% 1.2% 1.4% 0.9% Private Consumption Expenditure 2.7% -2.7% 0.5% 0.6% 0.9% 0.6% Private Housing Investment 8.3% -9.9% 2.8% 6.3% 0.5% 0.8% Private Capital Investment 7.0% 2.4% 0.6% 2.5% 2.7% 2.1% Public Consumption Expenditure 1.7% 0.4% 2.1% 0.4% 0.6% 0.7% Public Capital Investment 8.6% -2.1% -1.9% -3.2% 4.3% 0.3%Net Exports (contrib. to GDP growth) -0.5% 0.6% 0.1% 0.7% 0.4% 0.2% Exports 4.4% 8.8% 0.7% 3.1% 5.2% 2.3% Imports 7.1% 4.3% 0.2% -1.3% 2.9% 1.4%Nominal GDP 2.6% 2.0% 2.7% 1.0% 1.3% 1.6%GDP Deflator 0.0% 2.5% 1.5% -0.2% -0.0% 0.7%Industrial Production 3.0% -0.4% -1.4% 1.5% 3.8% 2.1%CPI (excl. fresh food) 0.8% 0.9% -0.1% -0.2% 0.7% 0.7%

FY16 FY18EFY13 FY14 FY15 FY17E

4

Public construction spending is forecast to pick up Order taking of public construction spending has picked up lately, which is forecast to feed through to the actual

spending with 2 to 3 months lag.

Public construction spending statistics(Monthly, seasonally adjusted, yen trillion)

0.00.20.40.60.81.01.21.41.61.82.0

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Order taking

Order taking 6M moving average

Total construction spending (public)

(Source) Cabinet Off ice, Ministry of Land, Infrastructure, Transport and Tourism,EAST JAPAN CONSTRUCTION SURETY CO., LTD, and compile by SMAM.

(Year)Note: Data is from Jan. 2007 to Apr. 2017

5

Private consumption for durable goods might be lifted by renewal demands in the near future There are early signs that private consumption for durable goods are increasing.

After the global financial crisis, Japanese government initiated incentives for purchasing such big ticket items as TV sets and new cars as the shaded period in the charts shows. The demand, however, slumped after the end of such incentives as the blue circle in the left chart shows.

Average lifetime for such durable goods are between 7 and 10 years, and renewal demands might be appearing.

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Trend line

Eco point subsidy

campaign period

Switchover from

Analogue to Digital

Broadcasting completed

Shipment of Visual Devices in Japan

Note: Data is monthly from Jan. 2005 to Apr. 2017, seasonally adjusted by SMAM.(Source) Japan Technologies and Information Technology Industries Association

(yen '00 million)

(Year)

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Subsidy for energy efficient

cars

New Car Registration in Japan('0000)

Note: Data is monthly from Jan. 2005 to Apr. 2017, seasonally adjusted by SMAM.(Source) Japan Automobile Dealers Association, Japan Mini Vehicles Association

(Year)

6

Capital expenditure is on the rise in line with the increasing operating cash flow Corporate Financial Statistics released by Ministry of Finance has a broad coverage of businesses including

non-listed companies.

Rising operating cash flow underpins capital expenditure by companies.

Restrained labor cost might be positive for shareholders in sharply rising profits, however, labor share should be increased in order for lifting private consumption in Japan.

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200 Recurring profit

CAPEX

Labor cost

OperationCash flow

Corporate Financial Statistics (for all industries, all size)

(Indexed 2011=100)

Note: Data is quarterly from 1Q 2000 to 1Q 2017.(Source) Ministry of Finance

7

Approval rating for Abe cabinet is deteriorating Approval rating for the Abe cabinet fell from 53% to 48% in June. Disapproval rating jumped from 30% to 36%.

“Kake-school scandal” is causing a damage to PM Abe’s reputation. He is suspected to have benefitted one of his closest friends in gaining approval of opening a school for a feline practitioner. Arrogantly looking passage of some national security related bills were also negative.

Tokyo Metropolitan Assembly election is held on 2nd of July. The party “Tomin 1st”, lead by the popular Governor Yuriko Koike, will gain many seats. If Democratic Party of Japan loses too many seats, the trouble for PM Abe could deepen further.

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Obuchi Mori Koizumi Abe 1 Fukuda Aso Hatoyama Kan Noda Abe 2 Abe 2 disapproval

Approval ratings of Japanese cabinets by Prime Ministers(%)

Note: Data is from Aug 1998 to June 2017(Source) NHK (Japan Broadcasting Corporation)

June apporove

48%disapporove

38%

Current Abe

(Month/Year)

Outlook for Japanese Stock Markets

8

Stock market outlook: Japanese stock market might follow the lead of the US market SMAM short-term view Japanese stock market might test the upside led by US stock market. Relatively attractive stock valuation

compared to US is a positive factor. Possibility of global risk events blowing out has receded at least for now. Longer-term outlook (6-months and beyond) Continuing expansion of global economy and corporate earnings would support the Japanese stock market in

the long term. Major risks are such as historically high stock valuation for US markets, deterioration of PM Abe’s political power, geo-political risk in East Asia and US politics.

Note: SMAM’s projection is as of Jun. 20 th, 2017 and subject to updates without notice.

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TOPIXForecast range upsideForecast range downside

TOPIX index forecast range by SMAM

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

(Points)

(Month/Year)Note: Topix data is from Jan. 5th 2015 to Jun. 23rd 2017.

Base scenario & Upside / Downside risks for our forecasts

Our Base Scenario is assuming the following views: • Practical Trump trade policies are made and serious trade disputes can be avoided. • Expansionary policies in US keep global economies on a growth path. • Japan’s private consumption to grow mildly supported by wage growth. • Japanese yen does not get extremely stronger beyond 100 yen against US$. • Further fiscal stimulus will be made and extra easy monetary policy should sustain economic growth in

Japan. • Tension in the East Asia does not ignite a war.

Upside Risks include:

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

Downside Risks include:

• Confrontational foreign policies taken by Trump presidency shake global trades. • Trump policies for stimulating US economy fail to pass US congress. • “Russia-gate” scandal flares up. • Populism gains in Europe further destabilizing EU. • Heightening geo-political tensions in Middle East & East Asia. • Rekindled concern over emerging economies including China. • “Moritomo” and “Kake” scandals make a fatal blow to PM Abe.

10

Note: SMAM’s projection is as of June 20th,, 2017 and subject to updates without notice.

11

Japanese stock market caught up with other markets in June

11

Europe took a breather in June. Rally continues for Emerging markets and US stocks.

Japanese stock markets made a catch-up move in June after lagging other markets.

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MSCIEM/US$

S&P500

TOPIX/US$

MSCIEurope/US$

TOPIX/Yen

US$ based performance of stock markets (Dec 2015 =100)

(Source) Datastream, MSCI and Tokyo Stock Exchange, compiled by SMAM.

Notes: Data is up to Jun. 23rd 2017.(Month/Year)

12

The latest 12M forward EPS forecast for TOPIX advanced steadily to 112. Historical EPS also advanced.

11.4% EPS growth is forecast in the coming 12 months.

EPS forecasts by analysts continue to expand

101

112

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Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

IBES EPS consensus forecast for TOPIX

Historical EPS(left) 系列2 12M EPS growth forecast(right)

Note: Weekly data from Jan. 5th 2011 to Jun. 16th 2017.

(Source) Datastream, IBES

(Points)

(Month/Year)

13

ROE recovery has been achieved by improving profit margin so far

13

ROE (Return on Equity) can be decomposed into the following. ROE = Financial Leverage * Asset Turnover * Net Income Margin (Total assets/ Shareholder equity) * (Sales/ Total assets) * (Net income/ Sales) Substantial improvement of Net Income Margin is very positive development, since this has been the biggest

factor why ROE of the Japanese companies are inferior to US companies.

As a whole, asset/ capital efficiency still need to improve despite positive efforts found in individual companies.

-2.0%

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Net Income Margin

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100%ASSETS TURNOVER

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Financial Leverage(times)

-4.0

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ROE(%)

Note: Data is quarterly from 1Q 2008 to 1Q 2017. (Source) FactSet and compile by SMAM

Decomposition of ROE for TOPIX

PER (Price Earnings Ratio) at 14x looks cheap compared to other markets

Japanese stock market valuation in TOPIX about the middle of the range between 12x and 16x after PM Abe’s second term began.

Based on 12M forward EPS of 112, TOPIX PER is calculated at just above 14x. PER for MSCI US index is 18x and for MSCI Europe is 15x, which makes Japanese stock market look attractive

in global comparison .

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Note: Data is weekly from May 30th 2008 to Jun. 16th 2017. TOPIX was 1596.04 at the end of the period. (Source) Tokyo Stock Exchange, Datastream and IBES, compiled by SMAM

TOPIX

(Month/Year)

TOPIX and PER based on 12-month forward EPS

16x

12x

13x

14x

15xPM Abe's 2nd term started

Foreign investors bought Japanese equities in May Foreign investors were buying Japanese equities in May and turned to sell slightly in June. Investors activities slowed in the first half of June.

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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 Jun.16th 2017.

2016(Month/Year)

2017

16

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demonstrate capabilities and expertise of Sumitomo Mitsui Asset Management Company, Ltd. (hereinafter “SMAM”), or to provide information on investment strategies and opportunities. Therefore this material is not intended to offer or solicit investments, provide investment advice or service, or to be considered as disclosure documents under the Financial Instruments and Exchange Law of Japan.

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