20th March 2014

by Mathieu LHoir
Research & Investment Strategy

Japanese equities and the yen

An almost 2-for-1 relationship

Key points

The Bank of Japans (BoJ) decision to embark on a

program of large-scale quantitative easing has
significantly weakened the Japanese currency.
Following the yens depreciation, Japanese
companies have preferred to restore margins rather
than increasing market share.
Our estimates show that there is roughly a 1-for-1
relationship between earnings and the yen, while
the sensitivity is 2-for-1 between stock prices and
the yen.
Since the capacity or willingness of the BoJ to
further weaken the yen seems to be diminishing, we
recommend remaining cautious and suggest a
neutral position on Japanese equities.

Exhibit 1
Earnings expectations are driven by currency gyrations
Japan: earnings forecasts and FX
64
62

Weakening of the yen

60

Topix 100 index 12-month forward EPS

(yen, IBES consensus) [Lhs]

58

USD/JPY currency, 2-month lead [Rhs]

106
102
98

56

94

54

90

52

86

50
48

Strenghtening of the yen

82

46

78

44
42
Mar-11

Sep-11

Mar-12

Sep-12

Mar-13

Source: Bloomberg, Datastream, AXA IM Research

Sep-13

74
Mar-14

Currency gyrations have been moving

Japanese equities
The BoJs decision to embark on a program of large-scale
quantitative easing to bring an end to the regime of falling
prices in Japan has significantly weakened the Japanese
currency over the past year. In fact, the yen has fallen by
close to 25% against the US$ since January 2013, with
Japanese equities up by 60% over the same period. The
correlation between Japanese equity returns and the yen
has surged, to the point where a 1% daily depreciation in the
yen leads to a 2-2.5% increase in Japanese stock prices
and vice-versa (Exhibit 2).
Exhibit 2
Almost 2-for-1 relationship between stock prices and yen
Japan: equity market and FX
125

Weakening of the yen

Index 100 = 31/12/2012

160
150

120

140
115
130
110

Strenghtening of the yen

105

USD/JPY [Lhs]

120
110

Topix 100 index, local currency return [Rhs]

100
Jan-13

Apr-13

Jul-13

Oct-13

Jan-14

100
Apr-14

Source: Bloomberg, AXA IM Research

A very large proportion of these synchronized movements

can be attributed to the behaviour of exporters. For instance,
the elasticity of Toyotas daily equity returns to FX changes
since January 2013 is roughly 3. One of the obvious
reasons put forth for these daily co-movements is the
impact of currency depreciation on the market share of
exporters and thus on earnings. However, we argue in
this note that this explanation is neither qualitatively nor
quantitatively fully satisfactory.

commodities are priced in US$. The result is higher

production costs, whose weight on margins depends on
pricing power. Similarly, exporters may decide not to
completely pass currency depreciation on to their foreign
customers, boosting margins rather than volumes. Again,
indices like the Topix 100, with a strong overseas revenue
base, are in a position to really take advantage of this
strategy, which is less the case for the MSCI Japan (320
stocks) and even less so for the Topix 1000.

The true relationship between earnings and

the yen
We know that both components (margins and revenues) are
highly pro-cyclical (Exhibit 3). Therefore, one needs to
adjust for the sensitivity of stock market earnings to FX
changes from spurious correlation effects by
controlling for domestic cyclical conditions when
estimating these sensitivities. Indeed, suppose that the
Japanese government introduces a fiscal stimulus, which is
good for economic activity and ultimately for corporate
revenues, while at the same time the BoJ injects liquidity so
as to weaken the yen. In this case, the simultaneity of both
effects, i.e., the weakening of the yen and improved
economic conditions thanks to the fiscal stimulus, can lead
to an overestimation of the sensitivity of earnings to FX
changes. FX changes are captured by the variation in the
real effective exchange rate (REER) in order to take into
1
account the multilateral dimension of trade relationships.
Exhibit 3
It is important to control for earnings pro-cyclicality
Japan: corporate profits, FX and cycle
100

106

80
60

104

Weakening of the yen

40

102

20
0

100

-20
-40

Currency drives earnings

Earnings growth can be broken down into top-line growth
and margin variation. In terms of top-line, exporting firms
may use currency depreciation to increase their market
share by adjusting prices in local currencies accordingly. At
the stock market level, the capacity to leverage currency
depreciation depends on the aggregate weight of exports vs.
domestic sales. Some indices are more domestic than
others; for instance, the share of total revenues generated
domestically is higher in the Topix 1000 than in the Topix
100. The latter is likely to benefit more from the plunge in
trade-weighted currency than the former.
Margins are the second parameter in the equation. Currency
depreciation affects the price of imported inputs. This is the
case for commodity importers like Japan, since most

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-60

98
Strenghtening of the yen

-80
-100
1995

Incorporated businesses, current profits - all indus., %yoy [Lhs]

96

Inverse of the real effective exchange rate, in %yoy [Lhs]

OECD Composite Leading Indicator [Rhs]

1997

1999

2001

2003

2005

2007

94
2009

2011

2013

Source: Bloomberg, Datastream, AXA IM Research

According to our estimates (from 1995 to end 2013), a 1%

depreciation in the Japanese real effective exchange

Technically speaking, we have regressed the Topix 100 and MSCI

Japan 12-month earnings growth on the year-on-year variation of the
Japanese real effective exchange rate and the Japan OECD composite
leading indicator. The time series used spans from January 1995 to
December 2013. The R squares of the regressions are 32% for the
Topix 100 and 37% for the MSCI Japan. All coefficients are statistically
significant at the 1% threshold.

rate leads to a 0.9% increase in corporate earnings as

far as the Topix 100 is concerned, and 0.5% if we
consider the MSCI Japan due to a higher domestic
2
exposure.

Exhibit 5
Weak yen boosted margins

Interestingly, this top-down estimate is close to what the

consensus bottom-up 12-month forward EPS revision
implies, i.e., roughly a 1-for-1 relationship between
earnings and the yen (Exhibit 1).

Japanese firms are restoring their margins

Since a large proportion of Japans exports are priced in
dollars, the yens depreciation provides limited support for
export volumes but boosts margins if companies decide not
to adjust their prices. The evidence is clear that this is the
strategy Japanese companies have decided to put in place.
First, exports have been unexpectedly weak recently despite
the yens significant depreciation. While Japans real
effective exchange rate depreciated by 25% between
September 2012 and December 2013, real exports were
virtually unchanged during the same period (Exhibit 4).
Exhibit 4
Real export growth has been surprisingly weak
Japan real exports and FX
110

Real exports, Index: 2010=100 [Lhs]

60

Real effective exchange rate index, [Rhs] inverted

105

Weakening of the yen

70
80

100

90
100

95
110

Strenghtening of the yen

90
Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13

120

Source: Bloomberg, AXA IM Research

More importantly, margins have more than doubled since

September 2012 (Exhibit 5), suggesting that Japanese
companies have preferred to restore their margins
rather than increase their market share. As shown in
Exhibit 5 the positive impact of currency depreciation seems
to have been stronger for the Topix 100 than the Topix
1000. This sharp improvement in margins has generated a
significant leverage effect on earnings, which explains a
large part of the earnings recovery of Japanese mega caps.

Japan profit margin and FX

7

Weakening of the yen

Topix 1000 profit margins, in % [Lhs]

115

110

Topix 100 profit margins, in % [Lhs]

5

120

105

USD/JPY [Rhs]

100

95
90

85
Strenghtening of
the yen

80
75

1
70
Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14

Source: Bloomberg, AXA IM Research

Investment implications
Our conclusion is that stock prices are twice as sensitive
to the yen as earnings. As a result, Japanese equities
have undergone a significant rerating since 2012
following the weakening of the yen. This suggests that
beyond the direct effect on earnings through its positive
impact on margins, the depreciation of the yen also
increases the likelihood that deflation should indeed come to
an end. This is a necessary though not sufficient condition
for an eventual revival of Japans economic growth potential,
something that the market is progressively pricing into
valuation multiples, which is creating volatility.
Consequently, one of two things will have to happen for
Japanese equities to continue rising going forward. First, the
yen must continue to depreciate, fuelling further upward
earnings revisions. Alternatively, domestic demand must
really take over, boosting the domestic revenues of
Japanese companies. There are substantial uncertainties
about these two conditions. On the one hand, the capacity
or the willingness of the BoJ to further weaken the yen
seems to be diminishing. On the other hand, inflation is
picking up while nominal wages are still stagnating, leading
to a decline in real disposable household income with a
consumer tax hike looming. The current wage negotiations
underway are therefore crucial. In the meantime, we
recommend remaining cautious and suggest a neutral
position on Japanese equities in equity portfolios.

For the sake of comparison, we have also computed the raw

sensitivities, i.e., without controlling for domestic cyclical conditions.
These raw sensitivities are 1.5% and 1.3%, respectively, for the Topix
100 and the MSCI Japan.
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