Japanese equities
Topix (27 June): 745 (last month: 721) UBS View Topix (6-month target): 780 ¢ We expect earnings growth of about 45% over the coming 12 months. This exceptional high growth is mainly due to the two natural disasters last year, as well as tax regulation changes which caused a number of one-time losses to be booked in the fiscal year that ended in March 2012. e In our base case scenario, we see only limited scope for an additional earnings boost from the local economic recovery, given the slowing in export markets. Japanese companies are expected to continue their cost reduction efforts to counter the impact of a strong yen. ¢ The Japanese government has started implementing its JPY 18tn recovery budget in 4Q 2011, and we expect the budget to boost Japanese GDP by 1-1.5% in FY2012. e Mainly due to the earnings rebound, we expect the TOPIX trailing P/E to drop from around 16.5x to 14x — 14.5x by year end; still the earnings rebound should provide some room for moderate price increases.
4 Positive scenario Topix (6-month target): 900 ¢ Stronger global demand and stabilizing European markets provide an additional boost to earnings, and also lead to improved risk taking. Falling risk aversion is likely to lead to a weaker yen, providing further upside to earnings. TOPIX target is based on 16.0x trailing P/E.
& Negative scenario Topix (6-month target): 600 ¢ Faltering global growth leads to weak exports, triggering negative earnings surprises. A strengthening USDJPY below 75 in response to rising risk aversion might provide an additional drag on the economy and earnings. We would then expect the P/E ratio to contract to 13.5x, even if earnings show no recovery.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
JPY and exports The exchange rate is an important factor for the Japanese equity market, and central bank intervention is a key swing factor. Japan’s trade balance could be in deficit and may impact USDJPY rates. Key date: 09 July, Japanese trade
balance
BoJ’s monetary policy
The Bank of Japan’s (BoJ) additional commitment to its asset purchase program, board meeting
which is currently JPY 65tn in size, would lead to a weaker yen, in our view. Key date: 12 July, BoJ policy meeting
36 UBS
For further information please contact ClO asset class specialist Toru Ibayashi, toru.ibayashi@ubs.com
Preference: neutral
Recommendations
Tactical (6 months)
e The earthquake in Japan and recent floods in Thailand have impacted Japanese earnings negatively. A recovery from these disasters should benefit auto and industrial stocks in particular.
e We prefer companies that continue cost reduction initiatives to maintain price competitiveness during the period of yen strength.
Strategic (1 to 2 years)
e A weaker USDJPY may drive Japanese companies’ earnings recovery beyond a technical recovery from natural disasters.
e Arapidly aging population and the lack of a powerful and stable government remain negative for the country's longer- term economic prospects.
Japanese realized earnings likely to recover going forward 95 8&5 75 65 55: 45 35 25 15 5 (5) 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
— Topix: 12m realized earnings per share
Source: Thomson Reuters, UBS CIO, as of 21 June 2012 Note: Past performance is not an indication of future returns.
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Please see important disclaimer and disclosures at the end of the document.
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