Pic By BLOOMBERG

We WROTE on the outlook for 2018 last year and highlighted that Japan was the dark horse to look at this year.

Prime Minister Shinzo Abe’s loose policy mix, strong growth anchor on current global economic recovery and robust external demand were all key catalysts.

Japanese equities have had one of their best starts into 2018 but the trend has fallen off as global markets turned on US inflation and global trade war concerns.

The Nikkei 225 is down 1.7% year-to-date. Given that, is the positive case for Japan still intact?

As a matter of context, the word “Shunto” refers to the annual wage negotiations between enterprise unions and the employers.

As Japan was struggling with recession and deflation on top of falling union membership, the automatic wage increases associated with the initiative came under threat until Abe’s administration came to power.

The Shunto results that started in March show that big Japanese companies have agreed to raise wages for a fifth successive year.

Although most of the companies fell short of government’s targeted 3% hike, the outcome should still help drive up domestic consumption.

On the monetary front, Bank of Japan (BoJ) chief Haruhiko Kuroda has pledged to continue pursuing monetary stimulus in close coordination with Abe, in order to achieve a 2% targeted inflation.

We do not foresee the BoJ to withdraw stimulus at least for the remaining of 2018. Subsequently, this should keep Japanese government bond yields suppressed for the time being, which will help keep some downward pressure on the yen.

At this juncture, the political scene is drawing most market concern now. Recent headlines of scandal involving the prime minister is hurting his approval ratings on the domestic front.

The market is interpreting this issue cautiously as it may affect the career longevity and economic policies and contribute to the volatility in Japanese equities.

Despite the scandals and political noise, Abe scored a major victory in the national election last year.

This portrays the confidence the Japanese people have in Abe and his policies. The victory leaves Abe leading his party, the Liberal Democratic Party (LDP), as there is no one within LDP stepping up to threaten Abe’s position as of now.

Hence, we see little threat towards the continuity of Abenomics and this essentially means Japan is still trekking towards better economic equilibrium and higher corporate profitability.

The continuation of Abe’s rule also translates to expansionary fiscal policies and more structural reforms ahead.

The primary objective of the government is to defeat inflation and increase labour productivity by 2020.

The post-election victory last year allowed the government to announce programmes designed to enhance social security and education, along with budget increment on infrastructure spending.

There is also a possible tailwind for investment activities amid preparation for the 2020 Olympics in Tokyo, hence, serving as a potential leg-up to Japan’s gross domestic product growth.

To sum it up, Japanese equities still look attractive due to the prospects for economic growth and corporate earnings.

There is still reasonable headroom for Japanese equities to trend higher, given their current progress towards reflation and continued profit growth.

Domestic demand and spending have started to gain traction.

Valuation wise, price earnings (PE) ratios are sitting at 15.7 times and 13.9 times for financial year 2018 (FY18) and FY19 respectively (as of April 11), against our fair PE value for the Japanese market, which is at 18 times.

Although Japanese equities offer decent upside potential, the road ahead is unlikely to be a smooth one as geopolitical tensions escalate and trade war worries will continue to linger.

Investors are advised to be wary of their equity exposures and the overall risk level of their investment portfolios.