Weak Dollar Saps Hopes for Year-End Nikkei Rally; Stocks Are Down 9.8% From a May 22 High, Largely Mirroring Currency Moves

Weak Dollar Saps Hopes for Year-End Nikkei Rally

Stocks Are Down 9.8% From a May 22 High, Largely Mirroring Currency Moves

BRAD FRISCHKORN

Updated Oct. 27, 2013 2:58 p.m. ET

TOKYO—A stubbornly strong yen appears to be vanquishing hopes among investors for a second rally in Japanese stocks this year. The sharp fall in Japan’s currency late last year had been a major factor in the 80% surge in the Nikkei Stock Average through May, as the dollar rose more than 30% to a high of ¥103.74. But stocks have been lackluster since falling into a bear market—defined as a 20% drop from a peak—in June. Stocks have recovered somewhat but the Nikkei is still down 9.8% from its May 22 high, largely mirroring the movement of the dollar against the yen.Friday’s 2.8% tumble in the benchmark index, putting it at 14088.19, was typical of the market’s recent woes, with stocks falling as the greenback slid below ¥97.

“The whole weak-yen, strong-stock market trading model which had been counted on to fuel higher and higher stock prices has unwound,” said Sumitomo Mitsui Banking Corp. strategist Daisuke Uno. He sees the dollar as low as ¥90 to ¥92 by the end of December, and the Nikkei trading at around 12500 as a result.

Among the bullish, where hope remains that shares can somehow recapture their lost magic, is Nomura Securities. The big Japanese brokerage stands by its 18000 Nikkei year-end target. But the prediction is largely dependent on a weakening yen, with Nomura’s forecast based on the dollar at ¥102. That is now looking less likely.

Amid signs that the Federal Reserve will continue its bond-buying program well into next year, the dollar has failed to take off this year as was widely expected. That keeps U.S. interest rates low and the U.S. currency less attractive for international investors.

UBS strategist Syed Mansoor Mohi-uddin projects the dollar at ¥103 over the next three months, compared with his previous target of ¥105, citing the Fed’s delay in pulling back on stimulus measures, while Junya Tanase, chief FX strategist at J.P. Morgan Chase, puts the dollar at ¥100 at year-end, down from a ¥105 projection previously.

Currency fluctuation can have a significant impact on corporate Japan. Toyota Motor Corp.7203.TO +0.97% estimates that every ¥1 move against the dollar can add or subtract ¥40 billion in profit.

For many investors, the question now is whether higher corporate earnings propelled by a broader economic recovery will come to the rescue for stocks. “The next step for stock investors will be to see if earnings expectations alone can be counted on to drive stock prices,” says Tachibana Securities market adviser Kenichi Hirano.

With the yen much weaker than the assumption used in most corporate forecasts earlier this year, forthcoming first-half earnings figures are considered safe. Most firms had used calculations ranging between ¥90 and ¥95. But there is doubt among some investors over the forecasts for the second half of the fiscal year that ends in March.

“Upward earnings revisions for the full year will be under close scrutiny,” says Naoki Fujiwara, fund manager at Shinkin Asset Management, which oversees ¥600 billion in assets. “The size of the revision changes will be key.”

Also overshadowing the market is exactly how far Prime Minister Shinzo Abe will go with his “Abenomics” program of structural overhaul. The Bank of Japan’s monetary-easing program and 2% inflation target are still only months old, while most of Mr. Abe’s ideas on tax incentives and deregulation have yet to be fleshed out or appear to be meeting with opposition.

Activist investor Daniel Loeb said in a newsletter that his $14 billion Third Point fund would be “eager buyers of additional Japanese stocks” beyond its significant investment in SonyCorp. 6758.TO +2.59% and current holdings in other Japanese companies, provided the prime minister acts on his reform plans.

Some other international investors agree, noting that Japan’s growth is the highest among major G-7 nations.

“With an annualized GDP of 4%, Japan remains attractive as both a recovery story and a growth story relative to elsewhere in Asia,” said Ed Rogers, CEO of Tokyo-based Rogers Investment Advisors, an asset manager that has overseen around $100 million via mostly hedged stock trading strategies this year.