Credit Suisse Downgrades Japanese Stocks, Says Deflation Could Come Soon

Credit Suisse has downgraded Japanese equities to benchmark, saying that the economy could return to deflation.
"On the current $/¥, Japan is set to return to deflation; earnings and PMI momentum have fallen sharply; there is little new news on the Third Arrow (with polls showing Abe's popularity fading and Abe focusing on constitutional change rather than deregulation/labour market reform)," analysts, including Andrew Garthwaite, wrote in a note this week.

"Many fundamental problems remain (such as trend growth of just 0.5% in an economy getting close to full capacity)," Garthwaite added.

The brokerage avoided an underweight because: "i) we believe the BoJ will remain committed to their inflation target ahead of July's election (and we place a reasonably high probability on more REIT/ETF buying and a supplementary budget); ii) there is some clear evidence of corporate change (buybacks are up >100% Y/Y)."

Garthwaite continued: "iii) the funds flow picture is the best of any market (foreign investors have capitulated, 53% of household's financial assets are in cash, and private/public pension funds and the BOJ could buy c.7.5% of market cap); iv) Japan scores top of our valuation scorecard; and v) finally, Japan is the most leveraged market to a rise in global PMI new orders."

The analyst noted that while the headline unemployment is extremely low by developed market standards (at 3.3 percent), there may be more hidden slack in the labor market.

"Our economists estimate that despite the job offer to applications ratio being close to a 25-year high, the U6 unemployment rate (i.e. the unemployment rate taking into account those workers who are marginally attached or working part time for economic reasons) is still high at 5.6%," Garthwaite said.

On the forex front, Credit Suisse's FX strategists forecast that USD/JPY will rise to ¥105 over the next 12 months.

The Credit Suisse Japan Focus List stocks include Sony Corp (ADR) SNE and Dai-Ichi Life Insurance Co., Ltd. DCNSF, both of which are cheap according to the firm's HOLT valuation model that ranks stocks based on discounted cash flows.

According to Tipranks, Garthwaite has a success rate of 67 percent, with average return per recommendation of +29.2 percent. He is ranked 1,461 out of 3,844 analysts.