Japanese Stock Market Outlook

SMAM monthly comments & views - August 2016 -

Japanese Economy

PM Abe announced yen 28 trillion fiscal stimulus, among which central and local government budget spending is planned at yen 7.5 trillion. Public sector is going to pull the economy ahead. Private consumption is forecast to show moderate growth whereas private capital investment is forecast to make a solid contribution.

• Inflation expectations are falling and BOJ slightly strengthened monetary easing on 29th of July by doubling the pace of

purchasing Japanese equity ETFs, however, other quantitative easing was not expanded and negative interest rate was

not touched this time.

• Impact of BREXIT on Japan is expected as limited and manageable as long as Japan’s major counter part regions, Asia

and US, keep growing rather solidly.

Japanese Stock Markets

BOJ’s additional easing to double the size of purchasing Japanese Equity ETFs is mildly positive for the stock market, although risk for higher yen remains. Large fiscal spending plan of yen 28 trillion over the coming years will be more or less positive for corporate sentiment.

• After downward revisions for a while, Japanese corporate earnings are expected to hit bottom during Jul-Sep period

and start to grow again, which could drive the stock market to move upward. SMAM forecasts recurring profit growth for

218 companies in SMAM’s research coverage to be +4.0% in FY2016.

• Global economic growth is gradually stabilizing although close attention is required for what effects Britain’s decision to

exit from EU brings in. Fiscal stimulus plan this time is over multiple years utilizing loan programs as well as budget

spending, which SMAM thinks positive compared to the previous cases, which tended to lack in long-term planning.

Executive summary

1

Notes: Macro and market views are as of Jul. 29th and 20th, 2016 respectively, and subject to updates thereafter without notice

Outlook for Japanese Economy

2

3

PM Abe announced yen 28 trillion fiscal stimulus, among which central and local government budget spending

is planned at yen 7.5 trillion. Public sector is going to pull the economy ahead. Private consumption is forecast

to show moderate growth whereas private capital investment is forecast to make a solid contribution.

Inflation expectations are falling and BOJ slightly strengthened monetary easing on 29th of July by doubling the

pace of purchasing Japanese equity ETFs, however, other quantitative easing was not expanded and negative

interest rate was not touched this time.

Notes: E=SMAM forecasts. SMAM views are as of Jul. 29th , 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

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% 1.5% 1.1%

Private Capital Investment 0.9% 3.0% 0.1% 2.0% 1.5% 1.0%

Public Consumption Expenditure 1.5% 1.6% 0.1% 1.5% 1.5% 1.1%

Public Capital Investment 1.0% 10.3% -2.6% -2.7% -0.1% 5.9%

Net Exports (contrib. to GDP growth) -0.8% -0.5% 0.6% 0.1% 0.3% -0.0%

Exports -1.4% 4.4% 7.9% 0.4% 1.7% 1.4%

Imports 3.6% 6.8% 3.4% -0.1% -0.0% 1.8%

Nominal GDP 0.0% 1.7% 1.5% 2.2% 0.7% 0.9%

GDP Deflator -0.9% -0.3% 2.4% 1.4% -0.0% 0.2%

FY15 FY17EFY12 FY13 FY14 FY16E

4

SMAM revised Real GDP forecast for Apr-Jun from -0.5% to +1.1% (annualized) considering better than

anticipated economic indicators released so far such as household survey and private capital investments.

SMAM quarterly economic outlook

Notes: SMAM views are as of Jul. 29th,2016 and subject to updates thereafter without notice. Source: Cabinet Office, Ministry of Economy, Trade and Industry, Ministry of Internal Affairs and Communications, SMAM forecasts .

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2

2013 2014 2015 2016 2017

Private consumption

Private Housing Investment

Private Capital Investment

Private Inventry Investment

Public consumption expenditure

Public Investment

Net Export

Real GDP

Forecast by SMAM

(QoQ %) Real GDP and contribution by components

5

Impact of BREXIT on Japan is expected as limited and manageable

UK accounted for 6% and 7% in foreign direct investments and its income in 2015. EU’s share was 15% and

11% respectively. In exports from Japan, UK’s share was 2% and EU 9%.

These numbers are not small, however, Japan’s major counter part regions are Asia and US. As long as these

two regions keep growing rather solidly, negative impact of BREXIT on Japanese economy will be limited and

manageable.

US, 15.2, 20%

Asia, 40.3, 53%

EU (ex. UK), 6.7,

9%

UK, 1.3, 2%

Others, 12.1, 16%

Total75.6

(Source) Ministry of Finance, Bank of Japan, compiled by SMAM

Regional distribution of Japanese international activities

*Data is for 2015. Exhibited are region, trillion yen, and % of total.

Direct foreign investments Exports Income from

direct foreign investments

US, 49.8, 34%

Asia, 42.5, 29%

EU (ex. UK), 22.2,

15%

UK, 10.4, 7%

Others, 22.9, 15%

Total147.8

US, 3.1, 29%

Asia, 4.4, 40%

EU (ex. UK), 1.2,

11%

UK, 0.7, 6%

Others, 1.5, 14%

Total10.8

6

Positive effect is expected from the fiscal stimulus measures for the medium term

On 2nd August, Cabinet office has decided on the fiscal spending plan to be sent to the next National Diet

session for approval. Total size is advertised to be yen 28 trillion, among which yen 7.5 trillion is directly spent

by central and local government budgets, and the rest is financed by loan programs.

Infrastructure spending is going to play a major role with the total size of yen 13.7 trillion, among which a) “21st

century projects” such as Linier High Speed Train and marine ports for cruise liners take yen 10.7 trillion and b)

“recovery from earthquakes and enhancing safety & protection against natural disasters” take yen 3 trillion.

Other measures include increasing minimum wage, supporting child & elderly care and giving benefit to low

income households.

15

16

17

18

19

20

21

22

23

24

25

26

2005 06 07 08 09 10 11 12 13 14 15 16 17 18

Real Public Capital Formation

Forecast including stimulus measures

Baseline forecast without stimulus measures

Forecast of Real Public Capital Formation (as a component of GDP, annualized)( trillion yen)

(Source) Cabinet Office, compiled by SMAM

SMAM forecast

7

Where the yen is heading ?

One thing worthy of note is the fact that pressure for the stronger yen from the inflation difference has ceased.

Inflation rate in Japan has risen while global inflation in general has substantially declined. This is exhibited as

sideways move of PPP lines on the chart for the last several years.

Historically, PPP based on CPI worked as the weaker end for Yen against US dollars, which was also the case

this time after the beginning of Abenomics so far.

Yen/Dollar rate seems to have been moving around PPI based PPP rate for the last 15 years and current rate is

also close to it.

0

50

100

150

200

250

300

350

400

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016

Yen/US$ rate PPP based on PPIPPP based on CPI PPP based on export price index

Purchasing Power Parity (PPP) exchange rates for Yen/US$

Note: PPP rates are calculated based on the yen/US$ rate of 265.96 as of Mar. 1973 and each price indices in Japan and US.(Source) US Department of Labor, US Department of Commerce, FRB, Bank of Japan, Ministry of Internal Affairs and Communication, and IMF, compiled by SMAM

(Yen)

8

Current balance is going to stay substantially positive in spite of only mild trade surplus

Current balance of Japan has almost recovered to historically high level, which is positive for the strength of

national finance.

Compared to 2000’s, trade surplus stays very mild this time, which is not a bad sign as recent current surplus is

sustained by income from foreign investments rather than massive exports since the latter could potentially

cause fragility to external economic shocks.

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

Trade balance

Current balance

Forecast by SMAM

Trade balance & Current balance as % of GDP

(Source) Ministry of Finance, Bank of Japan

9

Increase in number of employees is driving the growth in aggregated real income

Nominal wage increase seems to be in declining momentum recently, probably due to the rising cautiousness

among management of companies in global uncertainties.

If you look at it from a different angle, however, aggregated real income has been increasing rather solidly

driven by increase in number of employees, which is surely one of the underlying strengths of the Japanese

economy.

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

2012 2013 2014 2015 2016

Nominal wage

Number of employees

Inflation

Aggregated employees real income

(Source) Ministry of Health, Labor and Welfare

(%)

Aggregated employees' real income and contribution by components (YoY%)

Outlook for Japanese Stock Markets

10

Stock market outlook: waiting for effects of fiscal stimulus and global economic recovery

SMAM short-term view BOJ made additional easing on 29th July by doubling the size of purchasing Japanese Equity ETFs to annual

yen 6 trillion, which is mildly positive for the stock market, although risk for higher yen remains. Large fiscal spending plan advertised to be yen 28 trillion will be more or less positive for corporate sentiment.

Longer-term outlook (6-months and beyond) After downward revisions for a while, Japanese corporate earnings are expected to hit bottom during Jul-Sep

period and start to grow again, which could drive the stock market to move upward. SMAM forecasts recurring profit growth for 218 companies in SMAM’s research coverage to be +4.0% in FY2016.

Global economic growth is gradually stabilizing although close attention is required for what effects Britain’s decision to exit from EU brings in. Fiscal stimulus plan this time is over multiple years, which SMAM thinks positive compared to the previous cases, which tended to lack in long-term planning.

Note: SMAM’s projection is as of Jul. 20th 2016 and subject to updates without notice

11

700

900

1,100

1,300

1,500

1,700

1,900

Ja

n-1

3

Fe

b-1

3M

ar-

13

Ap

r-1

3

Ma

y-1

3

Ju

n-1

3

Ju

l-1

3

Au

g-1

3

Se

p-1

3

Oct-

13

No

v-1

3

De

c-1

3

Ja

n-1

4

Fe

b-1

4M

ar-

14

Ap

r-1

4

Ma

y-1

4

Ju

n-1

4

Ju

l-1

4

Au

g-1

4

Se

p-1

4

Oct-

14

No

v-1

4

De

c-1

4

Ja

n-1

5

Fe

b-1

5M

ar-

15

Ap

r-1

5

Ma

y-1

5

Ju

n-1

5

Ju

l-1

5

Au

g-1

5

Se

p-1

5

Oct-

15

No

v-1

5

De

c-1

5

Ja

n-1

6

Fe

b-1

6M

ar-

16

Ap

r-1

6

Ma

y-1

6

Ju

n-1

6

Ju

l-1

6

Au

g-1

6

Se

p-1

6

Oct-

16

No

v-1

6

De

c-1

6

Ja

n-1

7

Fe

b-1

7M

ar-

17

TOPIX

Forecast range upside

Forecast range downside

TOPIX index forecast range by SMAM

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

(Points)

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.

12

13

According to IBES, downward earnings revision is continuing at the moment. This is probably because

the current yen/dollar rate at around 105 is stronger than the assumptions for the exchange rate used

in forecasting earnings.

Currently, downward earnings forecast revisions are continuing probably adjusting to stronger yen

SMAM Corporate Earnings forecasts (218 Companies research coverage excl. financials)

Fiscal year FY 2014 FY 2015

Date of forecast Actual Actual as of 10th Jun 2016 as of 10th Jun 2016

Revenue (YoY %) 3.9% 0.1% -0.8% 2.7%

Operating Profits (YoY %) 3.1% 9.1% 0.6% 9.4%

Recurring Profits (YoY %) 4.5% 2.5% 4.0% 10.1%

Net Profits (YoY %) 5.4% -3.2% 12.5% 11.4%

Recurring profits (YoY %)

Manufacturing 135 companies 4.1% 0.2% 2.3% 11.1%

Non-manufacturing 83 companies 5.2% 6.5% 6.7% 8.4%

Note:Key assumptions for the forecasts, Yen/US$ 110, Yen/EUR 125, Crude oil $45/barrel

(Source) SMAM

FY 2016E FY 2017E

-30%

-20%

-10%

+0%

+10%

+20%

+30%

2011 2012 2013 2014 2015 2016

TOPIX Earnings Forecast Revision Index

Notes: Revision index= % of Analyst upgrades out of total Topix firms - % of downgrades. Calender year, weeklySource: IBES, SMAM Up to Jul. 18th 2016

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.

Even considering further down-revision in earnings, current TOPIX level does not look expensive.

14

300

500

700

900

1,100

1,300

1,500

1,700

1,900

Jan-0

7M

ar-

07

Ma

y-0

7Jul-0

7S

ep-0

7N

ov-0

7Jan-0

8M

ar-

08

Ma

y-0

8Jul-0

8S

ep-0

8N

ov-0

8Jan-0

9M

ar-

09

Ma

y-0

9Jul-0

9S

ep-0

9N

ov-0

9Jan-1

0M

ar-

10

Ma

y-1

0Jul-1

0S

ep-1

0N

ov-1

0Jan-1

1M

ar-

11

Ma

y-1

1Jul-1

1S

ep-1

1N

ov-1

1Jan-1

2M

ar-

12

Ma

y-1

2Jul-1

2S

ep-1

2N

ov-1

2Jan-1

3M

ar-

13

Ma

y-1

3Jul-1

3S

ep-1

3N

ov-1

3Jan-1

4M

ar-

14

Ma

y-1

4Jul-1

4S

ep-1

4N

ov-1

4Jan-1

5M

ar-

15

Ma

y-1

5Jul-1

5S

ep-1

5N

ov-1

5Jan-1

6M

ar-

16

Ma

y-1

6Jul-1

6

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 Jul.15th 2016 when TOPIX was 1317.10

TOPIX and PER based on 12-month forward EPS

16x

12x

13x

14x

15xPM Abe's 2nd term started

Is declining business momentum going turn around on much awaited fiscal spending plan?

BOJ makes broad based business survey every quarter and releases its result in early Jan. Apr. Jul. and Oct.

Manufacturing sector is showing some resilience after the decline in 1Q this year. On the other hand, robust

sentiment of non-manufacturing sector is gradually losing steam.

If the next fiscal spending plan can boost business sentiment again or not is important for the Japanese

economy and corporate earnings.

15

-30

-20

-10

0

10

20

30

1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q 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

Domestic investors were buying in June. Foreign investors turned net buyers in July.

Selling from foreign investors ceased and net purchasing was observed in the 1st half of July.

Domestic investors such as pension funds, business corporations have been constantly buying equities.

16

500

700

900

1100

1300

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

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 Group

Note: Data is for Tokyo stock exchange and Nagoya stock exchangeData for June is from May 30 th to Jul. 1st. and for Jul is from Jul.4th to 15th. Up to Jul. 15th 2016

2016

17

Disclaimer

Please read this disclaimer carefully. = This material is for non-Japanese institutional investors only. = The research and analysis included in this report, and those opinions or judgments as outcomes thereof, are intended to introduce or

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.

= The expected returns or risks in this report are calculated based upon historical data and/or estimated upon the economic outlook at present,

and should be construed no warrant of future returns and risks. = Past performance is not necessarily indicative of future results. = The simulated data or returns in this report besides the fund historical returns do not include/reflect any investment management fees,

transaction costs, or re-balancing costs, etc. = The investment products or strategies do not guarantee future results nor guarantee the principal of investments. The investments may suffer

losses and the results of investments, including such losses, belong to the client. = The recipient of this report must make its own independent decisions regarding investments. = The opinions, outlooks and estimates in this report do not guarantee future trends or results. They constitute SMAM’s judgment as of the date of

this material and are subject to change without notice. = The awards included in this report are based on past achievements and do not guarantee future results. = The intellectual property and all rights of the benchmarks/indices belong to the publisher and the authorized entities/individuals. = This material has been prepared by obtaining data from sources which are believed to be reliable but SMAM can not and does not guarantee its

completeness or accuracy. = All rights, titles and interests in this material and any content contained herein are the exclusive properties of SMAM, except as otherwise stated.

It is strictly prohibited from using this material for investments, reproducing/copying this material without SMAM’s authorization, or from

disclosing this material to a third party.

Registered Number: Kanto Local Finance Bureau (KINSHO) No.399

Member of Japan Investment Advisers Association, The Investment Trusts Association, Japan and Type Ⅱ Financial Instruments Firms Association

© Sumitomo Mitsui Asset Management Company, Limited