TOKYO -- Normal notions of where stock prices should bottom out are disappearing ahead of the U.K.'s referendum on European Union membership next week, as possible fallout from an exit vote threatens to send Japanese shares into a downward spiral.
The Nikkei Stock Average rebounded slightly Wednesday, adding 60 points to hit 15,919.58. But that hardly makes up for the 971 points lost over the previous four sessions. "The number of underpriced stocks has soared," said Kazuyuki Terao of Allianz Global Investors Japan. "But the general atmosphere is not one of active buying."
The potential for a Brexit, or U.K. exit from the EU, evidently looms large. "How far could prices tumble if the 'leave' camp carries the day?" a source at a foreign securities firm mused fretfully.
In ordinary times, a price-to-book value ratio of 1, indicating a share price matching a company's net worth per share, is often used to estimate a lower bound on a stock's price. A P/B ratio of less than one indicates, in theory, that investors would do better to purchase and break up the company than to trade in its shares.
The collective P/B ratio for components of the Nikkei average approached 1 in mid-February, as prices were tumbling throughout the market. At present, that ratio would be reached if the index were to drop to around 14,600, establishing that figure as a plausible bottom for the market.
But "the validity of the P/B ratio" as a value measure "is now declining," said Takaaki Yoshino, Daiwa Securities' chief quantitative analyst. This occurs when uncertainty runs rampant, inflamed by previously unanticipated risks -- for example, the terrorist attacks on the U.S. in September 2001. The largely unprecedented question of a Brexit provides fuel for similar market pessimism.
More concrete factors are also at play -- namely, foundering growth in companies' net worth itself. Japanese enterprises overall hardly saw any increase in net assets in the fiscal year ended March 31, according to Yuusuke Maeyama of the NLI Research Institute, presenting a stark contrast to brisk growth seen in other years since the 2008 financial crisis.
This is puzzling on its face, given that Japan Inc. pulled in record profit in fiscal 2015. Ordinarily, retained earnings would serve to grow net worth. But this failed to pan out last fiscal year, due largely to the strengthening yen: depreciation of assets denominated in foreign currencies neatly canceled out gains from accumulated profits, keeping net worth per share flat.
A strengthening of the yen to 100 to the dollar would alone dent net worth 3-5%, Maeyama reported. This in turn would let the Nikkei average fall another 500 to 600 points before hitting a P/B ratio of 1. The likelihood that a vote in favor of a Brexit would send risk-averse investors scrambling for the yen gives this scenario an unsettling degree of realism.
In such a case, "investors would be drawn to companies with steady, reliable growth in value," Kenji Abe of Okasan Securities said. These include food makers such as Kewpie and Ito En marked by steady profits and little exposure to the vagaries of the currency market, he said. Until storms across the sea stop sending waves Japan's way, companies serving the home market will most likely remain on top in Tokyo, supported by both strong earnings and robust asset values.