[TOKYO] Japan's stock market rally looks exactly the same as it did two years ago. And yet it's entirely different.
Just like in 2013, shares keep going up, with the Topix index closing on Thursday at a seven-year high. Prime Minister Shinzo Abe remains in power, and a weaker yen is boosting company profits.
What's changed: Drugmakers and paper mills are powering the advance in 2015. Brokerages, the biggest beneficiaries in Abe's first year, are slumping.
The reversal in fortunes shows changing sentiment about Japan's economy, with broader optimism giving way to cautious stock-picking focused on defensive industries, said Yoshihisa Okamoto, the Tokyo-based head of equity research at Mizuho Asset Management Co. The popularity of more stable equities is no reason to be bearish, he said, as the pattern is set to change.
"Worries about the economy are making investors feel they have to load up on defensive stocks," said Mr Okamoto. Also, "return reversal is occurring, with investors rotating from stocks they already owned in large amounts to ones that had initially been less popular. This trend has gone too far and it'll be difficult for it to continue." The Topix climbed 1.5 per cent on Thursday to the highest close since Dec 28, 2007. The Nikkei 225 Stock Average rose to within 1.6 per cent of a 15-year high as a weaker yen buoyed exporters and a report showed machine orders surged.
As the Topix jumped 80 per cent on optimism about Mr Abe's reforms to a peak at the end of 2013, brokerages couldn't rally fast enough, posting a 203 percent gain. Nomura Holdings, the biggest, surged 184 per cent to add 2 trillion yen (US$16.8 billion) to the value of its shares. Defensive equities were among the worst parts of the market to own, with health-care companies climbing 43 per cent in the same span.
The latest stage of the rally shows the opposite, with a 43 per cent slump by Monex Group leading declines by 18 of 22 listed brokerages from the start of 2014 through Thursday. In contrast, drugmakers as a group have rallied four times as much as the broader gauge since the start of the year. Otsuka, Takeda Pharmaceutical, and Eisai each jumped at least 20 per cent in 2015 through Thursday as the Topix added 3 per cent.
"The uncertain external environment for the market is leading to a process of elimination that favors defensives," said Takuya Takahashi, a senior strategist at Daiwa Securities Group.
Cracks appeared in Mr Abe's revival plan in April, when retail sales plunged 13.6 per cent on the previous month as a sales-tax increase started to weigh on consumer spending. By November, a report showed Japan was back in recession.
Foreigners added the least to Japanese stock holdings last year since they fled the market in 2008. Inflows dropped 94 per cent from 2013, when foreign buying sent the Topix to its biggest annual gain since 1999.
Jitters about Greece and Ukraine have added to woes this year, with Japanese equities placed 19th out of 24 developed markets tracked by Bloomberg.
The yen gained 1.9 per cent against the dollar through Feb 5, hurting the outlook for exporters' earnings. That changed after a Feb 6 report showed US employers added over a million workers in the last three months. Since then, the currency lost 1.8 per cent against the greenback as of 8 p.m. in Tokyo on Thursday. Data last month showed Japanese exports rose to the highest level since 2008.
"After the payrolls report, there are no doubts left about the strength of the US recovery," said Kiyoshi Ishigane, Tokyo-based chief strategist at Mitsubishi UFJ Asset Management Co. "Japanese stocks are at their best when the U.S. economy is strong and the yen is weak." The rally in health-care shares is a "bubble in risk aversion," and profit prospects mean the broader market will continue its uptrend, according to Nicholas Smith, a strategist at CLSA Ltd. in Tokyo. Smith expects consumer spending to improve as the drop in oil and a tighter labor market bolster household finances.
"You ain't seen nothing yet," he said. "Japan's the area of the world that actually has the strongest earnings growth. I'm calculating 12-month trailing, recurring pretax profit is up 12.6 per cent." Annual earnings on the Nikkei 225 Stock Average are poised to reach a record 21.4 trillion yen, according to estimates compiled by Bloomberg.
There are signs the economy is recovering from the sales- levy increase. Wages climbed for the first time in four years in 2014, unemployment set a 17-year low in December, while industrial production rose, data showed in the past two weeks.
The Topix traded at 15.8 times estimated earnings Thursday, against 16 at the end of 2007. The industry group tracking brokerages was valued at 12 times expected profits yesterday, compared with 29.7 times for the Topix Pharmaceutical Index.
Hajime Kitano, chief equity strategist at Barclays in Tokyo, says defensive shares are favored for the same reasons as bonds in times of pessimism. With deflation and negative interest rates spreading through the developed world, stock investors are uncertain about the future and going into survival mode, he said.
"In normal times, you'd want to sell these expensive defensive stocks and buy the cheaper financials," said Mr Kitano. "And that's precisely what we've seen over the past week. But the question is, will it continue? And to answer that, you need to ask: Is this a time of crisis or is it just normal?" Mizuho Asset's Okamoto says the mutation of the market toward risk aversion won't last much longer.
"As the yen weakens and the macro picture begins to recover, we should start to see selling in defensive names and buying of exporters," he said.