UBS Downgrades Japanese Equities to ‘Sell’

UBS has recently downgraded Japanese equities to a “sell” rating, indicating a shift in investment focus toward Europe and the UK.

Despite some structural improvements in Japan, UBS analysts believe that various cyclical challenges make Japanese stocks less attractive compared to those in Europe and the UK.

The downgrade reflects several risks facing the Japanese market, making it less appealing in the current global economic climate.

Economic Sensitivity

Japan’s economy features high operational leverage, which means corporate earnings are particularly sensitive to global economic changes. As global Purchasing Managers’ Indexes (PMIs) start to peak, indicating potential manufacturing slowdowns, Japan’s high leverage makes it vulnerable to downturns.

Heavy Reliance on China

Japan maintains substantial exposure to the Chinese economy, with exports to China making up 2.9% of its GDP, far surpassing Europe’s exposure. With China experiencing economic challenges, such as deflation risk and sluggish growth, this reliance poses significant risks to Japan’s economic stability.

Treasury Inflation-Protected Securities (TIPS) Yields

UBS forecasts 1.4% 10-year TIPS yields for year-end 2025, and Japan is expected to perform poorly as TIPS yields decline, further impacting market prospects.

Interest Rates and Currency Dynamics

UBS anticipates that the Bank of Japan (BoJ) will raise interest rates to 1% by mid-2025, contradicting current market expectations. A rate increase could bolster the yen, making Japanese products more expensive globally. Historically, a 10% appreciation in the yen correlates with significant underperformance in Japanese equities.

Corporate Governance

Though Japanese corporate governance is improving, it still lags behind Europe and the UK. Japanese firms are less likely to cancel share buybacks compared to their European counterparts, potentially diluting equity value over time. While Japanese stocks may look cheap, much of their perceived value comes from undervalued domestic stocks, whereas growth-focused stocks lack competitive pricing.

Favoring European and UK Equities

Contrarily, UBS identifies strong reasons to prefer European and UK equities. These regions have lower operational leverage, making them less exposed to global slowdowns. They also have less dependency on China, reducing associated risks.

UBS predicts interest rate cuts in Europe and the UK by 2025, expected to stimulate GDP growth by 1%, in contrast to Japan’s rising rates that could inhibit growth.

European equities offer better earnings revisions, higher buyback yields, and more favorable price-to-earnings ratios. Additionally, UBS forecasts that the yen will appreciate against the euro by 10% by the end of 2025, potentially diminishing the competitiveness of Japanese exporters in significant sectors like automobiles.