After April 2nd, uncertainty eases! Bank of America: Japanese stock market gradually recovers from April to June, with a full rebound in the second half of the year

Bank of America Securities believes that despite the current unclear market outlook, Japanese stocks have already reached a peak stage of uncertainty. They maintain the view that the market will gradually recover from April to June, expecting a comprehensive rebound in the Japanese stock market in the second half of the year.

Analysts stated that details of U.S. tariffs will be announced on April 2. Although the direct impact is significant, the indirect impact may be less than the trade frictions of 2018-19. In terms of valuation adjustments, Japanese stocks have begun to digest the impact of tariffs, with the P/E ratio declining and decoupling from earnings expectations, indicating that the market has priced in future earnings deterioration. Regarding inflation, the Bank of Japan is the only major central bank entering a rate hike cycle, but the benefits brought by inflation should outweigh the side effects of rate hikes, with Japanese stock ROE expected to break through the 9.5% mark in the second half of the year.

Three Major Turning Points in the Second Half of the Year

Bank of America analysts stated in a report on March 25 that as uncertainty arising from U.S. tariff issues and concerns about a U.S. recession intensify, market risk appetite has significantly weakened. After the details of U.S. tariffs are announced in early April, market volatility may continue, but the outlook will gradually become clearer. It is noteworthy that despite experiencing capital outflows, the Japanese stock market has begun to show downward resistance, with improved earnings expectations providing support for the market, a situation similar to that in 2022.

Analysts expect three major important changes in the second half of this year:

First, uncertainty will gradually ease. Tariffs are negotiation tools, and once implemented, negotiations between the U.S. and its trading partners typically accelerate. History shows that market concerns often peak after tariffs are implemented and then begin to ease. Additionally, as tax reduction bills approach passage, the motivation to impose new tariffs may weaken.

Second, the relative position of the Japanese stock market will improve. Currently, the rebound in European and Chinese stock markets is mainly driven by P/E increases rather than EPS or economic growth recovery. When EPS and the economy begin to recover, P/E ratios typically decline to appropriate levels and stabilize, leading to capital dispersing to other countries, while the recovery of the real economies in Europe and China will benefit Japanese companies.

Third, the benefits of inflationary economics and corporate reforms will gradually become apparent. Although the Bank of Japan is the only major central bank entering a rate hike cycle, the actual policy interest rate in Japan remains deeply negative, making it more accommodative compared to the positive real interest rates of other central banks. When negative interest rates were implemented in 2016, Japanese corporate profitability was not as strong as it is now. Significantly, industries positively correlated with interest rates account for 56% of total market capitalization, and both ROE and PB have improved compared to 2016.

The Impact of Tariffs Has Been Partially Reflected in the Market

Bank of America believes that the Japanese stock market has begun to price in the impact of tariffs. Although the correction index has improved, the P/E ratio has declined, indicating that the market has digested the deterioration in future earnings.

The previously proposed downside target corresponds to a P/E of 13 times (TOPIX: 2600, Nikkei 225: 36000). Considering that the P/E fell to this level on March 11 and the market rebounded, the adjustment has been quite sufficient, but the risk of another wave of selling after the details of the tariffs are announced on April 2 cannot be ruled out. If the situation worsens, the target P/E may drop to 12.5 times (TOPIX: 2500, Nikkei 225: 34500).

The dividends brought by corporate reforms will also limit the downside. Since 2023, dividend growth has outpaced EPS growth, making the undervaluation of stocks more apparent based on dividend yield. It is expected that when most companies announce their annual results in May, stock buybacks will reach their highest level.

The Inflation Dividend Will Exceed the Side Effects of Interest Rate Hikes

Bank of America stated that although the Bank of Japan is the only major central bank currently raising interest rates, its monetary policy remains more accommodative than other central banks with positive real interest rates due to Japan's actual policy rate being deeply negative. In addition, the nominal growth rate exceeds the cost of financing, which has helped Japanese companies achieve their highest profit margins since the fiscal year 2008 in the third quarter of fiscal year 2024.

The profitability of Japanese companies is currently in an interest rate hike cycle but has exceeded the level when the central bank introduced negative interest rates in 2016. Notably, the upper limit of ROE in recent years has been 9.5%, and it has now recovered to 9.4%. It is expected to break through 9.5% in the second half of this year and approach 10% next year. If achieved, overseas investors are more likely to shift their funds to the Japanese stock market. As uncertainty increases, Bank of America recommends that investors focus on domestic demand sectors in Japan, which are least affected by tariffs. At the same time, considering buying during the pullback of oversold large-cap blue chips is also an effective strategy