Profits to Drive Next Japanese Bull Market
After a long period of deflation and economic stagnation, the Japanese economy has finally turned a corner.
In the middle of this month, Goldman Sachs pointed out in its 2025 Japan Economic Outlook report that Japan has crossed a key inflation threshold - a benign "wage-price spiral" has emerged, a shift that has significant implications for both Japan and the global market.
Goldman Sachs forecasts that next year, Japan's consumption, exports, and capital expenditures are all expected to maintain an expansionary trend, which will promote an accelerated economic recovery, with real GDP growth reaching 1.2%.
A positive inflation and economic outlook will support the normalization of monetary policy. Goldman Sachs expects the Bank of Japan to raise interest rates by 25 basis points in January and July next year, with the policy rate reaching 0.75% by the end of 2025.
Considering the continued growth trend of corporate profits, Goldman Sachs is optimistic about Japanese stocks, expecting the TOPIX index to rise to 3100 points in the next year, 14.2% higher than Monday's closing price.
Inflation has passed a key threshold.
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After three decades of low inflation pressure, the rebound of inflation and wage growth led the Bank of Japan to exit its negative interest rate policy in March and raise interest rates again in July.
In the summer of 2024, Japan's base wage growth rate reached 3%, a level considered by the Bank of Japan to be consistent with sustainable inflation. Goldman Sachs also believes that this indicates that Japan's low inflation risk is over, and interest rate hikes will continue.
Its report predicts that in the spring 2025 wage negotiations, the base wage growth rate will remain at 3-3.5%, slightly lower than the 3.6% in 2024, but still at a high level, indicating that a benign "wage-price spiral" that helps anchor inflation expectations has emerged.
Considering the increased bargaining power of workers due to intensified labor shortages and an expanded job change market; large companies announcing significant wage increases to cope with future labor shortages, which also affects small and medium-sized enterprises that employ about 70% of Japanese workers; and continued corporate profit growth, we expect base wage growth to remain at a high level.
With wage growth, corporate service prices are also accelerating, and cost-push pressures from direct and indirect wage growth may further intensify, especially in labor-intensive service industries. Goldman Sachs estimates that if labor costs and corporate service prices both grow by 3%, and these increases are fully passed on, it will lead to an overall CPI increase of 1.1-1.5%, a key factor for sustainable inflation in the future.
In addition, further downward pressure on the yen may bring additional inflationary pressure to Japan. Goldman Sachs has raised its forecast for the US dollar against the yen from 149 to 159 yen in the next 12 months. The weakening of the yen this year has significantly pushed up prices since the summer.
Based on the revised forecast of the US dollar against the yen remaining at a high level of 150, Goldman Sachs expects Japan's core CPI (excluding fresh food and energy) to grow by 2.1% year-on-year in 2025 and by 2.0% in 2026, slightly exceeding the central bank's target.
The economy is accelerating its recovery, with consumption, exports, and capital expenditures all expected to maintain an expansionary trend.
Goldman Sachs expects the Japanese economy to accelerate its recovery in 2025, with real and nominal GDP growth rates reaching 1.2% (slightly higher than the potential growth of 0.7%) and 3.4% (more than double the average level of 1.6% from 2013-2019), respectively. The main drivers of this growth are the expansion of consumption and equipment investment.
The growth of real wages is expected to drive real consumption, while labor shortages, green transformation, digital transformation, and the continued expansion of corporate revenue are expected to drive an increase in equipment investment. As real wages increase, private consumption gradually increases. Goldman Sachs points out that although private consumption has declined in the past few quarters, it has shown stronger resilience to inflation as the "spring struggle" promotes the growth of real wages. Real wage growth turned positive in the summer of 2024, and this trend is expected to continue, supporting consumption growth.
Capital expenditures continue to grow moderately.
Due to corporate profits being at historical highs and business sentiment remaining positive, corporate capital expenditure plans are active, and capital expenditures are growing moderately.
Capital expenditures are not only driven by medium- and long-term demands unrelated to the business cycle (such as decarbonization and digital transformation) but are also affected by labor shortages. Due to a shortage of skilled workers in the construction industry, the construction cycle for factories and other facilities has been extended, and companies cannot fully implement their capital expenditure plans. However, as long as corporate investment intentions do not collapse under supply constraints, capital expenditures are expected to continue to grow moderately in the coming years.
Merchandise exports are expected to maintain moderate expansion. Despite some risk factors, Japanese merchandise exports will still grow moderately. This growth is mainly due to the normalization of Japanese automobile production and the stable semiconductor-related exports against the backdrop of moderate global economic growth.
The number of foreign tourists has returned to pre-pandemic levels.
The number of foreign tourists visiting Japan has returned to the 2019 level in 2024, and Goldman Sachs expects that the number of foreign tourists in 2025 will transition to a more normal trend, with an expected annual growth rate of 7%.
Monetary policy continues to normalize.
In 2024, the Bank of Japan raised the benchmark interest rate from -0.1% to between 0% and 0.1%, ending the negative interest rate policy that had lasted for eight years. This policy change marks the official abandonment of the Bank of Japan's negative interest rate policy and yield curve control policy, ending the era of large-scale economic stimulus. However, the interest rate hike was rapid but limited in scope, showing that the Bank of Japan's interest rate hike policy is a slow and steady approach.
At the same time, the positive inflation and economic outlook for next year will support continued interest rate hikes.
Goldman Sachs expects the Bank of Japan to raise interest rates by 25 basis points in January and July next year, with the policy rate reaching 0.75% by the end of 2025, and then continue to raise interest rates, bringing the terminal rate to 1.5% by 2027. If the yen depreciates to around 160 yen against the US dollar, the next interest rate hike may be brought forward from January 2025 to December 2024.
The normalization of monetary policy may have an impact on Japan's and the global financial markets, especially on those arbitrage transactions that rely on low-cost Japanese funds.
Corporate profits continue to improve, and TOPIX is expected to reach 3100 points.
This year, despite net sales of 5.1 trillion yen by foreign investors, the Japanese stock market has remained resilient, mainly due to the positive attitude of individual investors and companies towards the stock market and the increase in stock buybacks. Looking forward to 2025, Goldman Sachs expects the TOPIX index to achieve a positive return for the third consecutive year.
Specifically, Goldman Sachs expects the Japanese stock market benchmark index - the TOPIX index - to rise to 3100 points in the next year, 14.2% higher than Monday's closing price. The index has risen by more than 14% this year.
Returns will be mainly driven by earnings growth, not valuation expansion. Corporate profits have essentially been stagnant over the past decade, and Goldman Sachs believes that after a period of policy and corporate governance reform expectations, it is time to see these policies and reforms reflected in actual performance.
Goldman Sachs expects TOPIX's earnings per share (EPS) to grow by 30% in the fiscal years 2024-2026, with a price-to-earnings ratio of 14.3 times.
Goldman Sachs wrote: We expect the target price-to-earnings ratio to expand only moderately, with most of the upside coming from earnings per share growth. This price-to-earnings ratio should be achieved through a stable net inflow from foreign investors, individuals, and companies.
Goldman Sachs believes that investors focused on corporate fundamentals, should focus on industries that show significant differences in growth potential, market valuation, or shareholder participation, especially those that show appeal from an individual company analysis (bottom-up) perspective.
Focus on five major investment themes: monetary policy normalization, Japanese stocks heavily influenced by China, geopolitics, corporate transformation, and beneficiaries of AI in Japan.
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