Japanese equity response to post-quake yen
strength looks overdone

In recent years Japanese stock prices have
become less sensitive to a strong yen thanks
to manufacturers’ success in building
defenses such as offshore production. But
since the March 2011 earthquake, negative
equity impact from a strong yen has increased
again.

Funds have flowed into the yen because it is
the currency of an external net creditor. This
is in line with the risk-off mode prompted by
global financial market jitters which were in
turn caused by worsening US outlook and
Europe’s sovereign crisis. Normally,
Japanese corporate earnings should be the
basis for stock valuation but they appear to
have been outweighed by sentiment, in an
overreaction to strong yen negatives.

As an illustration, there has been a tendency
since summer 2008 forthe yen to appreciate
against the US$ when VIX is rising, and we
have found that this has nowbecome much
more pronounced. Since VIX is a measure of
implied volatility for US equities, it should
embody financial market jitters over the US
economy. Taking account ofhistorical levels
and looking at post-quake movement in
particular, we believe forex has reacted
excessively to a US-based shock.

Going forward, we expect the Japanese stock
market to return its attention to Japanese
corporate earnings fundamentals instead of
reacting excessively to a yen strength that
reflects global pessimism.