Japanese stocks remain undervalued
Japan's corporate and household sectors do not face as much balance sheet adjustment pressure as their US and European peers, but the economy remains quite vulnerable to external slowdowns and yen appreciation. Citi analysts expect economic activity to stay sluggish in the first half of 2012 before picking up later in the year thanks to moderately faster global growth and reconstruction demand from the earthquake.

Debates about the consumption tax hike will be a key policy issue this year. Prime Minister Noda plans to propose the consumption tax bill calling for the tax rate hike from 5% currently to 8% in April 2014 and to 10% in October 2015. If implemented, 2013 GDP growth could be pushed up by nearly 2% thanks to frontloaded demand ahead of price hikes, but growth in 2014 may worsen due to a reactionary decline in spending as well as a permanent negative impact on real household income.

Since August 1992, Japanese equities have experienced four bull markets and four bear markets, with each lasting 25 months on average. Estimating the annual rate of rise/decline for the coming 25 months from historical patterns, Citi analysts arrive at 18.8%. This suggests that TOPIX could rise above the trend line within the next two years. However, performance since the Lehman Brothers bankruptcy has undershot Citi's 25-month estimates. The recovery in share prices has further lagged the historical pattern because of the earthquake and Citi analysts feel performance over the near term could well undershoot their estimates.