December 22, 2017 / 8:21 AM / a year ago

Cheap valuations, strong profits, set Nikkei up for second year of gains

TOKYO, Dec 22 (Reuters) - Aided by a strong global economy, Japanese stocks’ cheap valuations and strong corporate earnings will likely see the market post a second year of significant gains in 2018, analysts said this week.

Ten market participants’ polled by Reuters forecast the Nikkei share average would range between 20,000 to 26,000 for 2018, compared to 22,902.76 on Friday.

It hit as high as 22,382.15 in November, the loftiest since early 1992 in the final days of Japan’s asset bubble when asset prices were extremely inflated.

“People who compare the current market with the real estate bubble in the 1980s have to be aware that this rally is fuelled in large part by earnings, not just hopes,” said Kazuhiro Takahashi, an equity strategist at Daiwa Securities.

He expects the Nikkei to reach as high as 26,000 next year, about 14 percent higher than the current level.

Japanese stocks are currently trading at 15 times their projected earnings, compared with a much more aggressive valuation of more than 50 times their projected earnings in 1992, according to Daiwa Securities.

Daiwa expects that Japanese firms would report a 16.7 percent rise in their pretax profits for the year ending March 2018 and another 8.5 percent gain for the following year, thanks to a weak yen and global growth.

Japanese stocks have attractive valuations compared to their global peers. The 12-month forward price-to-earnings ratio of the broader Topix index is 15.82, less than the S&P 500 Index’s 23.58, the FTSE 100 Index’s 20.39 and the pan-European STOXX 600 index’s 17.9, according to Thomson Reuters Eikon.

Strong U.S. economic growth will also help the Japanese market.

The U.S. economy grew at a 3.3 percent annualised rate in the third quarter, the fastest in three years.

The U.S. unemployment rate, which has an inverse relationship with Japanese stocks, was at a 17-year low of 4.1 percent.

“The combination of gradual U.S. rate hikes and low inflation is positive for stocks, so unless this condition collapses, the market should be strong,” said Soichiro Matsumoto, chief investment officer Japan at Credit Suisse, who expects the Nikkei to trade as high as 25,500 next year.

The financial sector has underperformed the market by 40 percent since 2013 when the overall market started rallying on the back of hopes that Abenomics will inflate the economy.

At its peak in early 2007 the financial sector its market capitalisation of 68.8 trillion yen accounted for 19.1 percent of the Tokyo Stock Exchange’s first section.

It has shrunk to 50.5 trillion yen, or 12.0 percent of the sector’s market cap, as of Friday, according to Nobuya Endo, managing director and head of global equity beta solutions at State Street Global Advisors.

The financial sector, which has underperformed the market more than any other sector, has room to rise in 2018 if yield curves steepen, Endo said. He noted that the financial sector, under favourable conditions, “should help lift the overall market”.

Reporting by Ayai Tomisawa

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