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Over about the past month I've written about the consistent gains by the Nikkei 225 and what looks to be a nice finish to a bumpy '06. Japanese financial stocks however, have struggled, and are not taking part in the year-end rally.

The simple analysis of why Japanese indices are up -- especially the N225 -- but not bank stocks is because of (1) the weak yen and (2) the 0.25% Bank of Japan target interest rate.

Also keeping downward pressure on banks is the fact that both Goldman Sachs and Credit Suisse have lowered their target share prices on the closely followed 3 mega banks [Mitsubishi UFJ Fin. Group (NYSE:MTU) (Tokyo: 8306), Mizuho Financial Group (NYSE:MFG) (Tokyo: 8411) and Mitsui Sumitomo Financial Group (Tokyo: 8316)] over the past week (see details below).

Meanwhile, the advance-decline line of the broader TOPIX has actually been unimpressive in recent trading with it having gone from heavily favoring advancers, to being flat and now to leaning heavily towards decliners. Since the BoJ did not raise rates again earlier this week, nobody feels the need to rush out and buy bank stocks. And since the yen continues to trade around ¥118/$1, so-called exporter stocks are in high demand.

This is potentially dangerous, especially if the yen were to strengthen suddenly, which has happened in the past. However, I have a positive take on the situation, based on a positive overall outlook for Japan in '07.

First, I don't expect exporter stocks to sell-off too heavily when (not if) the yen appreciates in '07, particularly against the dollar, as the BoJ does some hiking (which will be a boost for the margins at banks). Second, given the calendar year weakness in financial stocks and the bank-heavy, broader TOPIX lagging the N225 (see chart at the end), I see a lot of buy interest in it both domestically and from overseas.

Some other positive catalysts for bank stocks include stronger balance sheets as NPLs decline, public-borrowed funds are repaid, and from diversification into asset management and the potential to take business away from consumer finance firms and expand credit card operations. Also, let's not forget the mega banks are boosting dividends.

Now, on to the analyst ratings I mentioned above. Yesterday, Goldman Sachs lowered its target share price on two of the mega banks and raised it for one of them, while maintaining its ratings.

  • Mitsubishi UFJ: "neutral" rating maintained, ¥1.89m ($15.96) --> ¥1.69m ($14.27)
  • Mizuho FG: "neutral" rating maintained, ¥1.35m ($22.80) --> ¥1.01m ($17.06)
  • Mitsui Sumitomo FG: "buy" rating maintained, ¥1.37m -->¥1.43m
  • (Note: $ figures are ADR equivalents at ¥118.4/$1.)

    In a short note published by Japanese news service FISCO, Goldman reportedly said it likes Mizuho best among the mega banks. It said GS sees improvement on weakness in its retail banking chain and expects it to grow its market share of home mortgages and other retail banking businesses. Note that Mizuho beat larger rival Mitsubishi UFJ in receiving financial holding company status in the U.S., while its rival was ordered to improve its banking practices in the U.S. There is also news Mizuho will raise $3.4b by issuing preferred securities, all part of its overseas growth strategy concentrated on the U.S. (hence its recent NYSE listing).

    Last week Credit Suisse maintained its ratings on the mega banks while lowering its target share prices of each.

  • Mitsubishi UFJ: "neutral" rating maintained, ¥1.588m ($13.42) --> ¥1.554m ($13.13)
  • Mizuho FG: "outperform" rating maintained, ¥1.069m ($18.06) --> ¥947 thousand ($16.00)
  • Mitsui Sumitomo FG: "outperform" rating maintained, ¥1.409m -->¥1.398m
  • (Note: $ figures updated to reflect change in exchange rate to ¥118.4, from ¥117.4 in original post.)

    Mitsubishi UFJ closed today down 1.33% at ¥1.48m ($12.50), Mizuho was down 0.47% at ¥848k ($14.32), and Mitsui Sumitomo was unchanged at ¥1.22m.

    With the yen trading where it is against the US$ and given the weakness in bank stocks, it may be a good time to establish a position (or accumulate) in Mitsubishi or Mizuho, since they have ADRs and any yen appreciation would benefit their shares. I am considering buying, especially on weakness over the next couple of weeks. A majority of economists expect the BoJ to raise rates either in January, or some time in Q1. Speculation of a rate hike, especially based on strong consumer spending both in Japan and the U.S. could lead to buying of mega banks.

    1-year comparison chart of Mitsubishi UFJ (Tokyo: 8306), Mizuho (Tokyo: 8411) and Mitsui Sumitomo (8316) versus the N225 (code: 998407) and TOPIX (code: 998405):

    Click to enlarge chart

    1yr-chart-N225-Topix-MegaBanks-12-22-06


    Disclosure: The author does not own shares of any companies mentioned in this article.

    Source: Still No Love for Japan's Mega Banks