May 2, 2014 1:00 pm JST

Japan's stock investors hungry for economic reform

MASATAKA MAEDA, Nikkei senior staff writer

TOKYO -- The year has not been kind to the Japanese stock market so far in 2014. Of the world's 83 bourses, only Russia's has done worse.

     Although long-term investors may see this as a good buying opportunity, a lack of movement on basic economic reforms is making them hesitate.

     For Japan, it has been feast or famine. Contrast the poor performance of the last few months with the "Abenomics" rally that began on Nov. 14, 2012. Since then, the Nikkei Stock Average has underperformed Germany's DAX, the French CAC40, and U.S. Dow Jones Industrial Average in dollar terms. In 2013, it was a different story. By the end of that year, the Nikkei was the top performer. The big difference in the two phases was the activity of foreign investors in Japan. 

     Between November of 2012 and December of 2013, foreign investors bought a net 17.14 trillion yen of Japanese equities. This year they have reversed course, selling 1.47 trillion yen more than they have bought.

     Some overseas investors complain about a lack of momentum in Prime Minister Shinzo Abe's economic reforms. "Most foreign investors that have been actively trading Japanese stocks are hedge funds. Their focus may have shifted from Japan's economic revival to the recovery of European countries," said a strategist with a Japanese investment advisory.

Jumping the gun

But looking at the fundamentals of listed companies, price levels for Japanese shares are not extremely high. Although the numbers are still trickling in, there is a good chance Japanese companies, taken as a whole, will see record net profits for the year through March 2014. Manufacturers have performed well due to the weaker yen and continuous cost cutting. Domestically focused services have also enjoyed solid profits, thanks to a surge in demand ahead of the consumption tax increase.

     As of the end of April, the average price-earnings ratio of listed stocks on the first section of the Tokyo Stock Exchange was about 14. That is lower than in the U.S., with a ratio of 16 and France, at 14.9.

     Recognizing this, and leaving aside hedge funds with a relatively short-term focus, some investors have begun increasing their exposure to Japanese equities. "They are buying Japanese stocks based on bottom-up research on individual companies," said a small-cap stock analyst. The question is whether or not this trend will continue and spread. "Most foreign investors are not negative (toward Japanese stocks), but they are not able to find sufficient reason to move ahead," according to one Japanese strategist.

     What would give them reason to do so? One favorable bit of news is a possible change in the portfolio mix of Japan's public pension fund. The Government Pension Investment Fund, with assets of about 128 trillion yen ($1.24 trillion) as of the end of 2013, is planning to put more of its money into equities. But even if this gives a one-time boost to the stock market and delights short-term players, it is unlikely to persuade long-term investors to jump in. They are looking for more profound changes in the Japanese economy.

     A final agreement on the Trans-Pacific Partnership, big reductions in corporate taxes, a restart of Japan's nuclear power plants or a fundamental shift in immigration policy may be what is needed to attract long-term investment from overseas. Ordinary Japanese are also waiting for change.