What caught my eye? v - Macquarie€¦ · What caught my eye? v.102 global harbour for 2019? Key...

Please refer to page 22 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.

12 December 2018 Global

EQUITIES

MQ – Japan ‘Quality Sustainable Growth’ Portfolio – back testing

Source: Factset; MSCI; Macquarie Research, December 2018; Portfolio selections and stocks are in Table 49, p15

Japan – Corporate ROE (%) – at the highest level since mid-1980s

Source: Datastream; Macquarie Research, December 2018

Inside

Japan – a perennially underappreciated

economy 2

Modest expectations and high ROE –

a good mix 13

Appendices 16

What caught my eye? v.102 Is Japan a safe global harbour for 2019?

Key points

Japan remains an exception to the rules & shows path forward for the world.

High savings, no FX mismatches, productivity, innovation & BoJ are key.

Corporates are in rude health; score on leverage, EPS, ROEs & valuations.

Japan exceptionalism is likely to be durable, reducing…

As discussed in our ‘19 preview, investors are facing risks arising on almost every

front, from monetary and fiscal policies, politics and trade, valuations & corporate

returns. It just might all fall into place, but that would be nothing short of a miracle.

The winds of change and volatilities are likely to buffet US, EU & Chinese

markets, while EMs remain on tender hooks of US$, global liquidity and trade.

However, there is one major market, which just might avoid most of the extremes.

Japan has always been an exception and an asterisk to key developments over

the last three decades. It has been occasionally regarded as a weak link in the

chain that is just about to break and at other times it has been viewed as a true

visionary, pointing to our common financial & technological future. Betting against

¥ has been the widowmaker trade for longer than some of our clients were alive

while its industries have been perpetually written-off, only to see them resurrected

in a different form. Its services has been criticised for low productivity, only to be

partially resuscitated by a rapid inflow of tourists while Japan has also become

the world’s second-largest exporter of royalties and intellectual capital. Over the

last decade, its productivity has not lagged DMs and even exceeded some EMs.

Despite terrible demographics, Japan has never embraced immigration, and thus

it has avoided social dislocations, while BoJ is methodically taking care of debts.

Japan has consistently broken rules of conventional economics, and did not just

get away with it but in fact prospered, with per capita income maintained at a high

level throughout a three-decade transition, following the ‘body blow’ of the early

1990s that was at least five times greater than GFC. While pessimists argue that

the day of reckoning has not been abolished but simply deferred (i.e. ‘Japan is a

bug in search of a windshield’ argument), this view has over the years become

less believable or sustainable, particularly as the rest of world has been

converging on the Japanese model. It now seems to be just ahead of the curve.

…volatility and providing greater stability in a turbulent world

In our view, five factors have enabled Japan to turn conventional economics on

its head: (a) high level of savings and low international ownership of its debt and

securities, with no currency mismatches; (b) high degree of state control and

influence, as Japan has never been a conventional capitalist economy; (c) trust in

institutions of state, and hence, limited pressure of capital outflows; (d) egalitarian

income distribution and ethnically homogeneous population; and (e) corporate

sector, which though not as good as it could be at commercializing new products,

has proven to be innovative, pushing frontiers and complexity. These factors

remain as pertinent today as they were in ‘90s, perhaps even more so, as Japan

has also gained deep experience in managing a financialized economy.

At the same time, the beaten down Japanese investors are averse to bullishness

with neither EPS estimates nor multiples being at a significant variation to the

likely outcomes (unlike, US or EMs, where expectations are still too high) while

corporate ROEs have returned to mid-1980s levels. These micro factors are also

buttressed by a higher predictability of BoJ policies (vs Fed or ECB). The only

uncertainty is the next stage of consumption tax. What is there not to like?

90

100

110

120

130

140

150

De

c-1

6

Ja

n-1

7

Feb

-17

Mar-

17

Apr-

17

May-1

7

Ju

n-1

7

Ju

l-17

Aug

-17

Sep

-17

Oct-

17

No

v-1

7

De

c-1

7

Ja

n-1

8

Feb

-18

Mar-

18

Apr-

18

May-1

8

Ju

n-1

8

Ju

l-18

Aug

-18

Sep

-18

Oct-

18

No

v-1

8

Japan QSG Price Performance relative to MSCI Japan

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

De

c-8

0

De

c-8

2

De

c-8

4

De

c-8

6

De

c-8

8

De

c-9

0

De

c-9

2

De

c-9

4

De

c-9

6

De

c-9

8

De

c-0

0

De

c-0

2

De

c-0

4

De

c-0

6

De

c-0

8

De

c-1

0

De

c-1

2

De

c-1

4

De

c-1

6

Japan market - ROE

http://www.macquarie.com/research/disclosures

Macquarie Wealth Management What caught my eye? v.102

12 December 2018 2

Japan – a perennially underappreciated economy

‘Japan is a Bug Searching for a Windshield’, John Mauldin

In our view, few economies have been more misunderstood and underappreciated than Japan’s

(perhaps China’s economy comes in as the second in line). The above quote from an investment

book eight years ago exemplifies the conventional wisdom about Japan: having transferred

US$6 trillion from the private to the public sectors between 1991 and the early 2000s, the only way

forward is either a deflationary restructuring of monumental proportions or (more likely) an inflation

of debt away, with the concurrent currency collapse.

A modern version of the classic Hick’s liquidity trap kept at bay by the BoJ

Indeed, in many ways, this has been the view of most economists, who have always believed that

nominal growth (whether real or inflation) is the only solution to the debt overhang (Paul Krugman

was highlighting it as early as 1997/98, and hence, his advocacy for a much more robust monetary

and fiscal response to overcome the ‘liquidity trap’ conditions and Bernanke had a similar advice in

2003). In Krugman’s famous words, in order to succeed, BoJ must promise to be ‘credibly

irresponsible’ and arguably since the ascension of Shinzo Abe and Haruhiko Kuroda to power in

2012, Japan has been following the core premise that the only way for private sector to change its

deeply imbedded deflationary mindset is to become convinced that changes in monetary policies

are permanent rather than temporary responses (i.e. become ‘credibly irresponsible’).

As can be seen below, while BoJ initial responses in 1990s were somewhat muddled, the last

decade has witnessed a far more robust and consistent expansion of the monetary base, which

has broadly coincided with the end of private sector balance sheet de-leveraging. Out of Abe’s

infamous three arrows (i.e. monetary, fiscal and structural reform), only monetary has flown at a

full speed, with fiscal continuing to muddle with counter-productive consumption tax increases

intertwined with annual ‘supplementary budgets’. The structural arrow (as always) is something

that is in the eye of the beholder but from our perspective, very little has actually occurred. The

robust response by the Fed in the early months of the liquidity trap (2009), can be contrasted by

much more muted (until recently) response by ECB and even more muted initial response by BoJ.

Fig 1 Monetary Base (months since asset bubble burst) – Massive acceleration in Japan

Source: Bloomberg, Macquarie Research, December 2018

In some ways, Krugman and Bernanke were proven partially right, as Japan has recently

experienced a mild degree of nominal GDP acceleration, following decades of stagnation. The

same occurred to household and business expectations of inflation. The liquidity trap model, which

argues that monetary policies turn impotent when an economy falls into liquidity trap and that only

very aggressive policies can coax it out, has proven to be at least partially correct. However, as a

result, the BoJ is now sitting on over 100% of Japan’s GDP and controls around 50% of

JGBs. It has been recently forced to widen trading ranges (to 0.2%), as otherwise there was

simply no longer any meaningful volume in a JGB market, and any semblance of a price discovery

has largely disintegrated.

100

200

300

400

500

600

700

800

900

1,000

1,100

1,200

1,300

34

5

33

2

31

9

30

6

29

3

28

0

26

7

25

4

24

1

22

8

21

5

20

2

18

9

17

6

16

3

15

0

13

7

12

4

11

1

98

85

72

59

46

33

207

Japan US Eurozone

Japan has been a

consistently

misunderstood

economy

Has BoJ become

credibly irresponsible?


12 December 2018 3

Fig 2 Japan – National Debt to GDP (%) – stabilized at just over 5x, with public sector shouldering…

Fig 3 Japan – Private sector Debt to GDP (%) - …a significant decline in private sector debt commitments

Source: CEIC; Macquarie Research, December 2018 Source: CEIC, Macquarie Research, December 2018

Fig 4 Japan – Core CPI ex Food, Energy & Consumption Tax (%) – managing to stay just above zero…

Fig 5 Japan – Household Expectations of Inflation – …as more people believe that there would be some inflation


Fig 6 Japan – BoJ Assets (% GDP) – closing on 100% of GDP and…

Fig 7 Japan – BoJ (% of JGB) - …close to 49% of outstanding JGBs


0%

100%

200%

300%

400%

500%

600%

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

20

18

Public Non-financial Business Household Finance

525%

250%

0%

50%

100%

150%

200%

250%

300%

350%

400%

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

20

18

Non-financial Business Household Finance

370%

220%

300%

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Ja

n-0

5

Aug

-05

Mar-

06

Oct-

06

May-0

7

De

c-0

7

Ju

l-08

Feb

-09

Sep

-09

Apr-

10

No

v-1

0

Ju

n-1

1

Ja

n-1

2

Aug

-12

Mar-

13

Oct-

13

May-1

4

De

c-1

4

Ju

l-15

Feb

-16

Sep

-16

Apr-

17

No

v-1

7

Ju

n-1

8

CPI - ex Food and Energy

0.2%

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

Apr-

04

De

c-0

4

Aug

-05

Apr-

06

De

c-0

6

Aug

-07

Apr-

08

De

c-0

8

Aug

-09

Apr-

10

De

c-1

0

Aug

-11

Apr-

12

De

c-1

2

Aug

-13

Apr-

14

De

c-1

4

Aug

-15

Apr-

16

De

c-1

6

Aug

-17

Apr-

18

HH expecting prices to go up less than 2%

HH expecting prices to go up more than 2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Mar-

10

De

c-1

0

Sep

-11

Ju

n-1

2

Mar-

13

De

c-1

3

Sep

-14

Ju

n-1

5

Mar-

16

De

c-1

6

Sep

-17

Ju

n-1

8

BoJ/GDP

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

Apr-

01

Ja

n-0

2

Oct-

02

Ju

l-03

Apr-

04

Ja

n-0

5

Oct-

05

Ju

l-06

Apr-

07

Ja

n-0

8

Oct-

08

Ju

l-09

Apr-

10

Ja

n-1

1

Oct-

11

Ju

l-12

Apr-

13

Ja

n-1

4

Oct-

14

Ju

l-15

Apr-

16

Ja

n-1

7

Oct-

17

Ju

l-18

BoJ % of JGB


12 December 2018 4

So what’s next for BoJ, JGBs and the Japanese economy?

The conventional economics would argue that nothing has changed, and that BoJ has simply

delayed the day of reckoning. Given that Japan continues to maintain expansionary fiscal policies

(deficits), if it tries to ‘live within its means’ by closing these deficits, the country would be plunged

into an immediate and deep recession. As in Eurozone (think of Greece), this would lead to an

explosion of debt to GDP ratios, suddenly making something that is just bearable into

unsustainable. On the other hand, if the Government somehow manages to ignite even a mild

inflation, interest rates would increase, and the debt burden would quickly become unsustainable

and potentially unserviceable. Also, if investors genuinely believe that inflation would take off, why

would they continue buying JGBs? If Japan attempts to significantly cheapen its currency, it could

easily cause a global currency devaluation spree, and in view of Japan’s central positioning in

almost all of the world supply chains, it would ignite global deflation. On top of that, Japan’s rapidly

deteriorating demographics hampers its ability to accelerate real GDP growth rates.

As in a ‘Catch 22’, these are the nightmares from hell, and given that Japan is still the third-largest

economy in the world and the second-largest debt market, implications for both global economy

and Central Bank policies are immense. Hence, Japan has been regularly characterized as one of

the world’s key systemic flash points.

There are no conventional rules in a modern world & Japan was always different

Indeed, if Japan was a conventional economy, it would have by now gone through a purgatory of

multiple debt defaults, IMF bail-outs and revolutions. However, thankfully, Japan is neither a

conventional society, nor is it a conventional economy, while the world and its rules are

increasingly tilting towards Japan and its business model. In our view there are several key factors

that have differentiated (and protected) Japan in the past, and these factors continue to exercise a

strong gravitational pull, negating most of the traditional economic views.

1. First, Japan (as a nation, rather than just households) continues to maintain high

saving rates. On a sectoral basis, the private sector is currently saving ~6-7% of GDP,

while the public sector is dissaving less than 3% of GDP, implying an excess capital that

is not used within Japan of ~3-4% of GDP (or in other words, Japan continues to run a

persistent current account surplus). As a result, Japan remains a net export of capital.

While this clearly implies that the country is essentially riding global cycles, rather than

contributing to net global demand, it does provide a great deal of flow stability, with

foreigners still owning only ~11–12% of Japanese bonds. Thus, Japan not only borrows in

its own currency (and hence no FX mismatches), it also remains a predominantly

domestic financial market.

Fig 8 Japan – Sectoral Balances (Quarterly) (% of GDP)

Fig 9 Japan – Sectoral Balances (Annual) (% of GDP) – 1980-2017


-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

De

c-9

8

Mar-

00

Ju

n-0

1

Sep

-02

De

c-0

3

Mar-

05

Ju

n-0

6

Sep

-07

De

c-0

8

Mar-

10

Ju

n-1

1

Sep

-12

De

c-1

3

Mar-

15

Ju

n-1

6

Sep

-17

ROW Private Sector Public Sector

Saving

Spending

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

Private Sector Government ROW

Saving

Spending

While conventional

economics expects an

ultimate dislocation…

…we believe that there

are factors that protect

Japan…

…including high saving

rates and no FX

mismatches


12 December 2018 5

Fig 10 National Saving Rates (% GDP) – remain at ~27–28%

Fig 11 Japan – Foreign Bond Ownership (%) – only ~12%, though up from 6–8% twenty years ago

Source: IMF; Macquarie Research, December 2018 Source: ADB, Macquarie Research, December 2018

2. Second, disinflationary climate, high national saving rates and the aggressive posture by

BoJ, implies that interest payments as a proportion of government spending is only

~5%, compared to 11–12% in the early 1990s. At the same time, Japan has maintained

market credibility by selectively boosting and adjusting national commitments to elderly

and medical care while irregularly pushing up consumption tax (with the next rise due in

October 19). Although some of these measures are counter-productive, they have thus

far placated global markets, and precluded a panic setting in.

As Paul Krugman once famously remarked, ‘we know that advanced economies with

stable governments that borrow in their own currency are capable of running up very high

levels of debt without crises’. This particularly applies to any country that

systematically manages market expectations and generates surpluses (a la Japan).

Fig 12 Japan – Government – Revenue & Expenditure (% of GDP) – persistent but a controlled gap

Fig 13 Japan – Government Interest Servicing (% of expenditure) – down to only 5%, thanks to prudent management & BoJ


3. Third, Japan has remained an exceptionally homogeneous society, and a strong

consensus has formed over the last two decades that maintenance of cohesion

and existing per capita income levels should be the key objective of national

policies. While this does imply growing frictions between younger and older generations,

and inequality is gradually rising, it enabled the country to overcome a body blow that was

at least 5x more severe than the Global Financial Crisis. It should be kept in mind that

Japanese losses (real estate and equities) in ‘90/91, exceeded US$15 trillion (or 3x

GDP). For perspective, US losses during GFC were less than one-fifth of that level.

As can be seen below, Japan’s per capita income (2010 US$) is today broadly equal to

Germany and 10% ahead of France and perhaps not much more than 10–15% below the

10

15

20

25

30

35

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

20

18

Japan US Eurozone UK

-

2

4

6

8

10

12

14

Mar-

98

Ju

n-9

9

Sep

-00

De

c-0

1

Mar-

03

Ju

n-0

4

Sep

-05

De

c-0

6

Mar-

08

Ju

n-0

9

Sep

-10

De

c-1

1

Mar-

13

Ju

n-1

4

Sep

-15

De

c-1

6

Mar-

18

Japan

25.0%

27.0%

29.0%

31.0%

33.0%

35.0%

37.0%

39.0%

41.0%

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

Gov Rev to GDP Gov Exp to GDP

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

Gov Interest to Expense ratio

…ability to control yield

curve and experience of

maintaining trust…


12 December 2018 6

US. It is remarkable how following the debacle of 1990/91, Japan managed to keep its

relative per capita income flat for more than two decades. This even applies if we use

PPP adjustment, which traditionally penalizes Japan. While, it is true that today’s Japan is

only a fraction of its relative size and importance vs late 1980s/early 1990s, the country

has essentially achieved a ‘tranquil autumn’ of a civilized relative stagnation.

Fig 14 Japan – GDP/Capita (%) – (US$ Constant 2010) Fig 15 Japan – GDP/Capita (%) – (US$ 2011 PPP)

Source: World Bank; Macquarie Research, December 2018 Source: World Bank, Macquarie Research, December 2018

Fig 16 Japan – Gini Coefficient – 2007-16 – remains egalitarian

Fig 17 Japan Land Prices Index – loss of US$13 trillion in 1990s

Source: OECD; Macquarie Research, December 2018 Source: CEIC, Macquarie Research, December 2018

Fig 18 Japan – Equity Market Loss in 1990s (Yen Trillion)

Fig 19 Global – Share of GDP (PPP) (%) – down from 9% to 4%

Source: CEIC; Macquarie Research, December 2018 Source: IMF, Macquarie Research, December 2018

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

Japan (% OECD) Japan (% Germany)

Japan (% France) Japan (% US)

60%

70%

80%

90%

100%

110%

120%

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

Japan (% OECD) Japan (% Germany)

Japan (% France) Japan (% US)

0.20

0.22

0.24

0.26

0.28

0.30

0.32

0.34

0.36

0.38

0.40

US

UK

Spa

in

Austr

alia

Ita

ly

Ja

pa

n

Ca

na

da

Fra

nce

Kore

a

Ge

rman

y

Sw

eden

2007 2016

0

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

160

180

200

Mar-

55

Feb

-58

Ja

n-6

1

De

c-6

3

No

v-6

6

Oct-

69

Sep

-72

Aug

-75

Ju

l-78

Ju

n-8

1

May-8

4

Apr-

87

Mar-

90

Feb

-93

Ja

n-9

6

De

c-9

8

No

v-0

1

Oct-

04

Sep

-07

Aug

-10

Ju

l-13

Ju

n-1

6

Commercial Residential, rhs

0

100

200

300

400

500

600

700

Ja

n-7

1

Mar-

72

May-7

3

Ju

l-74

Sep

-75

No

v-7

6

Ja

n-7

8

Mar-

79

May-8

0

Ju

l-81

Sep

-82

No

v-8

3

Ja

n-8

5

Mar-

86

May-8

7

Ju

l-88

Sep

-89

No

v-9

0

Ja

n-9

2

Mar-

93

May-9

4

Ju

l-95

Sep

-96

TSE Market Capitalization (Yen Trillion)

Loss of ~US$2 trillion

0

2

4

6

8

10

12

14

16

18

20

0

1

2

3

4

5

6

7

8

9

10

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

Germany Japan China, rhs

…consensus about

maintenance of stability

& relative income


12 December 2018 7

4. Fourth, apart from the role that the state and BoJ have played in relieving the private

sector from its excessive debt burden accumulated during the 1980s (and the corporate

sector is now in truly rude health), the ability of Japan to maintain its relative income

levels has been boosted by the country’s consistent track record of maintaining

innovation and keeping the complexity of the economy high. As highlighted in our

past reviews, complexity ratios are some of the best indicators of the capacity to maintain

income while keeping income and wealth inequalities in check (here).

While Japan has never been very good at commercializing inventions (from flat screens

to Walkman), it has consistently been good at staying on top of R&D, patents and

complexity indices. This in turn has been translating into a steady TFP (or multi-factor

productivity) of at least 25bps-75bps per annum. This has recently been better than most

DMs and indeed even some EMs (such as China, Malaysia, Brazil or South Africa).

Fig 20 Global – Triadic Patent Families (% share) – Japan has consistently controlled over 30% of global patents

Fig 21 Global – R&D Spending (% of GDP) – Japan consistently spends around 3–3.5% of GDP

Source: OECD; Macquarie Research, December 2018 Source: World Bank, Macquarie Research, December 2018

Fig 22 Global – Economic Complexity Indices – Japan remains consistently the most complex economy in the world

Fig 23 Key Economies – Total Factor Productivity – following collapse in 1980s-90s, Japan’s TFP steadied over the last decade

Source: Complexity Atlas; Macquarie Research, December 2018 Source: TED, Macquarie Research, December 2018

1996 2000 2005 2010 2015 Per Capita (m)

Japan 27.1% 32.2% 29.2% 35.1% 31.2% 137.8

US 33.0% 28.1% 28.6% 24.4% 26.7% 46.5

EU 33.6% 31.8% 30.3% 25.3% 24.4% 26.6

-Germany 14.1% 13.7% 11.8% 9.7% 8.0% 54.3

-France 5.5% 5.3% 5.0% 4.7% 4.6% 39.7

-UK 4.3% 4.2% 3.6% 3.2% 3.3% 27.9

China 0.1% 0.2% 0.9% 2.7% 5.2% 2.1

Korea 0.8% 1.6% 4.5% 4.7% 4.9% 54.1

Switzerland 2.1% 1.8% 1.8% 2.0% 2.2% 160.9

ROW 3.4% 4.3% 4.8% 5.6% 5.5% 0.6

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Kore

a

Ja

pa

n

Taiw

an

Ge

rman

y

US

Fra

nce

Sin

g

Austr

alia

Ch

ina

Ca

na

da

UK

Ita

ly

Spa

in

Mala

ysia

Ru

ssia

Bra

zil

Turk

ey

India

HK

G

SA

Mexic

o

Tha

iland

Phili

ppin

es

Indo

n

2000 2015

-0.3

0.0

0.3

0.5

0.8

1.0

1.3

1.5

1.8

2.0

2.3

2.5

2.8

Ja

pa

n

Sw

itze

rla

nd

Ge

rman

y

Kore

a

Sw

eden

UK

US

Fra

nce

Ch

ina

Tha

iland

Mala

ysia

Turk

ey

Bra

zil

India

SA

Ind

on

esia

Average (1995-2000) Average (2010-2016)

1980-1989 1990-1999 2000-2009 2010-2016 2013-2016

China 0.6 1.2 1.9 0.4 -0.6

Japan -1.2 -1.1 -0.5 0.5 0.2

Malaysia -1.2 -1.2 0.1 -0.4 -0.6

Korea 0.2 0.5 0.7 0.4 0.1

Taiwan 2.4 1.0 0.6 1.2 0.2

Canada -0.1 0.2 -0.6 -0.1 0.0

US 0.7 0.8 0.6 0.2 -0.1

Australia 0.4 0.8 -0.3 -0.2 0.1

France 0.8 -0.1 -0.4 -0.2 -0.2

Germany 0.8 0.4 -0.3 0.7 0.4

Italy 1.0 0.1 -1.1 -0.2 -0.2

Spain 1.4 -0.4 -1.0 -0.3 0.1

UK 0.6 0.1 0.2 0.0 0.1

The country is boosted

by its strong presence

in R&D, patents &

complexity


12 December 2018 8

Fig 24 Japan – Non-Financial Corporate sector – Debt & Cash (¥ trillion) – very strong corporate balance sheets…

Fig 25 Japan – Non-Financial Corporate Sector – Net Debt/EBITDA (X) – …. leverage is the lowest since early 1980s

Source: MoF; Macquarie Research, December 2018 Source: MoF, Macquarie Research, December 2018

5. While its demographics are appalling, Japan is showing that in a modern world,

productivity is not driven by youth and vigour, but rather by increasing automation, and

high participation rates by older cohorts. Japan’s installation of robots as well as

penetration of robots per 10,000 employees is either second or third highest amongst the

key economies. The country is also becoming a force in the deployment of service robots.

Fig 26 Industrial Robots Density (per 10,000 employees) - 2017

Fig 27 Installation of New Industrial Robots (‘000) – 2015-17

Source: IFR; Macquarie Research, December 2018 Source: IFR, Macquarie Research, December 2018

Fig 28 Labour Participation Rate (45y-54y cohort) (%) Fig 29 Labour Participation rate (over 65 years cohort) (%)


-30

20

70

120

170

220

0

100

200

300

400

500

600

Mar-

70

Mar-

72

Mar-

74

Mar-

76

Mar-

78

Mar-

80

Mar-

82

Mar-

84

Mar-

86

Mar-

88

Mar-

90

Mar-

92

Mar-

94

Mar-

96

Mar-

98

Mar-

00

Mar-

02

Mar-

04

Mar-

06

Mar-

08

Mar-

10

Mar-

12

Mar-

14

Mar-

16

Mar-

18

Debt Cash & Deposits RHS

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Mar-

71

Mar-

73

Mar-

75

Mar-

77

Mar-

79

Mar-

81

Mar-

83

Mar-

85

Mar-

87

Mar-

89

Mar-

91

Mar-

93

Mar-

95

Mar-

97

Mar-

99

Mar-

01

Mar-

03

Mar-

05

Mar-

07

Mar-

09

Mar-

11

Mar-

13

Mar-

15

Mar-

17

Net Debt/EBITDA (x) Average (1970-2015)

2.7x

710

322 308

200 197

97

0

100

200

300

400

500

600

700

800

Korea Germany Japan US Taiwan China

units

Global Density = 850 20 40 60 80 100 120 140 160

China

Japan

Korea

US

Germany

2015 2016 2017

76.0

78.0

80.0

82.0

84.0

86.0

88.0

90.0

Ja

n-0

7

Ju

l-07

Ja

n-0

8

Ju

l-08

Ja

n-0

9

Ju

l-09

Ja

n-1

0

Ju

l-10

Ja

n-1

1

Ju

l-11

Ja

n-1

2

Ju

l-12

Ja

n-1

3

Ju

l-13

Ja

n-1

4

Ju

l-14

Ja

n-1

5

Ju

l-15

Ja

n-1

6

Ju

l-16

Ja

n-1

7

Ju

l-17

Ja

n-1

8

Ju

l-18

Japan US

45-54Y

13.0

15.0

17.0

19.0

21.0

23.0

25.0

27.0

Ja

n-0

7

Ju

l-07

Ja

n-0

8

Ju

l-08

Ja

n-0

9

Ju

l-09

Ja

n-1

0

Ju

l-10

Ja

n-1

1

Ju

l-11

Ja

n-1

2

Ju

l-12

Ja

n-1

3

Ju

l-13

Ja

n-1

4

Ju

l-14

Ja

n-1

5

Ju

l-15

Ja

n-1

6

Ju

l-16

Ja

n-1

7

Ju

l-17

Ja

n-1

8

Ju

l-18

Japan US

Over 65Y

Automation & high

labour participation

rates overcomes

demographics


12 December 2018 9

6. Although in minds of most investors it is primarily associated with industrial strengths,

Japan is actually picking up a lot of steam in external services. In particular, Japan’s

current account balances are increasingly supported by growing tourism flows (with the

latest numbers setting multi-decade highs), a growing contribution from license fees and

royalty payments as well as burgeoning returns on overseas investments.

As can be seen below, Japan last year (‘17) exported almost US$42bn of license fees

and royalties (the second-highest globally) and generated net surplus of US$21bn. This

compares to ‘10 exports of US$27bn or a CAGR of ~7% over the last decade. As in the

case of patents, neither Korea, China nor Taiwan come anywhere near close to the depth

and strength of Japan’s intellectual property exports. At the same time, tourist arrivals to

Japan have reached the highest ever level of more than 2.6m per month (or about 32m

per annum) and since 2015, the net trade travel balances have become consistently

positive. Although clearly the weaker ¥ helped, the improvement was also due to a

greater promotional support, better infrastructure and Japan’s improving rating in tourism

competitiveness. Indeed, over the past decade, Japan has been the single best improver

amongst major developed economies, with its ranking in WEF’s Tourism competitiveness

rising from 25th in 2007 to 22nd in 2011 and to the 4th ranking globally in 2017.

Fig 30 Key Exporters of License & Royalty Fees (US$ bn)

Fig 31 Japan – Intellectual Exports & Net Balances (¥ bn) – balances turned positive since 2004

Source: UNCTAD; Macquarie Research, December 2018 Source: CEIC, Macquarie Research, December 2018

Fig 32 Japan – Tourism Arrivals & Departures – 12mma (‘000) – the highest level of arrivals ever

Fig 33 Japan – Net Travel & Tourism Balance (¥ bn) – turned strongly positive since 2015


Exports 2010 2011 2012 2013 2014 2015 2016 2017

US 107.5 123.3 124.4 128.0 129.7 124.4 124.5 127.9

Japan 26.7 29.1 31.9 31.6 37.4 36.5 39.2 41.7

Switzerland 13.4 15.8 17.3 18.6 18.2 16.2 21.0 21.6

Germany 8.2 10.7 10.3 13.6 15.5 15.2 17.6 19.6

France 13.6 15.3 12.7 13.1 14.6 15.1 15.5 16.4

UK 16.5 17.0 15.5 17.3 19.8 19.4 17.1 16.9

Italy 3.6 4.0 4.1 3.7 3.3 3.0 3.4 4.6

Korea 3.2 4.4 3.9 4.3 5.2 6.2 6.6 7.1

Singapore 1.0 1.7 1.9 3.2 3.8 8.8 7.4 8.3

Taiwan 0.5 0.8 0.9 1.0 0.9 1.2 1.2 1.7

China 0.8 0.7 1.0 0.9 0.7 1.1 1.2 4.8

Net Balance

US 75.0 87.2 85.8 89.2 87.7 84.6 80.1 79.6

Japan 7.9 9.9 12.0 13.8 16.5 19.4 19.5 21.1

Swizerland 5.3 5.1 6.2 6.8 4.1 3.3 8.9 10.2

Germany 1.2 3.3 3.9 4.9 4.8 5.5 7.1 7.8

France 3.6 4.8 4.0 2.1 1.8 0.7 2.3 3.1

UK 6.9 5.9 6.3 7.4 9.4 6.4 5.1 4.8

Italy (2.9) (2.6) (1.5) (1.7) (1.9) (1.3) (1.3) (0.2)

Korea (6.0) (3.0) (4.7) (5.5) (5.4) (3.9) (2.8) (2.1)

Singapore (15.9) (18.3) (20.8) (19.7) (17.0) (13.1) (11.1) (11.6)

Taiwan (4.5) (5.0) (4.7) (4.2) (4.4) (4.4) (4.1) (2.1)

China (12.2) (14.0) (16.7) (20.1) (21.9) (20.9) (22.8) (23.8)

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000D

ec-9

6

No

v-9

7

Oct-

98

Sep

-99

Aug

-00

Ju

l-01

Ju

n-0

2

May-0

3

Apr-

04

Mar-

05

Feb

-06

Ja

n-0

7

De

c-0

7

No

v-0

8

Oct-

09

Sep

-10

Aug

-11

Ju

l-12

Ju

n-1

3

May-1

4

Apr-

15

Mar-

16

Feb

-17

Ja

n-1

8

12M Sum of Monthly Net Balance

12M Sum of Monthly Charges of Intellectual's Use Export

12M Sum of Monthly Charges of Intellectual's Use Import

JPY bn

0

500

1,000

1,500

2,000

2,500

3,000

De

c-6

2

Apr-

65

Aug

-67

De

c-6

9

Apr-

72

Aug

-74

De

c-7

6

Apr-

79

Aug

-81

De

c-8

3

Apr-

86

Aug

-88

De

c-9

0

Apr-

93

Aug

-95

De

c-9

7

Apr-

00

Aug

-02

De

c-0

4

Apr-

07

Aug

-09

De

c-1

1

Apr-

14

Aug

-16

12MMA of Visitor Arrivals 12MMA of Residents Departure

Thousand Person

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

De

c-9

6

No

v-9

7

Oct-

98

Sep

-99

Aug

-00

Ju

l-01

Ju

n-0

2

May-0

3

Apr-

04

Mar-

05

Feb

-06

Ja

n-0

7

De

c-0

7

No

v-0

8

Oct-

09

Sep

-10

Aug

-11

Ju

l-12

Ju

n-1

3

May-1

4

Apr-

15

Mar-

16

Feb

-17

Ja

n-1

8


12M Sum of Monthly Travel Service Export

12M Sum of Monthly Travel Service Import

JPY bn

Japan is also becoming

a significant external

services provider but…


12 December 2018 10

Fig 34 Japan – Investment Flows (¥ bn) Fig 35 Japan – Key CA Service net exports (¥ bn)


7. Domestic productivity (or lack of it) has always been Japan’s ‘Achilles heel’. As can

be seen below, it still remains so, but on a number of metrics, Japan is really not that

much different to most comparable (in terms of living standards) countries (such France,

Germany or Australia or its immediate neighbour, South Korea). On average, Japan’s

domestic sectors only have ~60–70% of the US domestic productivity. The gap is

particularly pronounced in construction, transportation and storage.

Fig 36 Domestic Services (ex-Utilities) – GVA/Employee (US=100)

Fig 37 Construction – GVA/Employee (US=100%)

Source: CEIC; ILO; Macquarie Research, December 2018 Source: CEIC; ILO; Macquarie Research, December 2018

Fig 38 Wholesale/Retail Trade, Hotels – GVA/Employee (US=100)

Fig 39 Government Services – GVA/Employee (US=100%)

Source: CEIC; ILO; Macquarie Research, December 2018 Source: CEIC; ILO; Macquarie Research, December 2018

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

De

c-9

6

Oct-

97

Aug

-98

Ju

n-9

9

Apr-

00

Feb

-01

De

c-0

1

Oct-

02

Aug

-03

Ju

n-0

4

Apr-

05

Feb

-06

De

c-0

6

Oct-

07

Aug

-08

Ju

n-0

9

Apr-

10

Feb

-11

De

c-1

1

Oct-

12

Aug

-13

Ju

n-1

4

Apr-

15

Feb

-16

De

c-1

6

Oct-

17

Aug

-18


12M Sum of Investment Income Inflow

12M Sum of Investment Income Outflow

JPY bn

-36,000

-30,000

-24,000-18,000

-12,000

-6,000

06,000

12,000

18,000

24,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

De

c-9

6

Mar-

98

Ju

n-9

9

Sep

-00

De

c-0

1

Mar-

03

Ju

n-0

4

Sep

-05

De

c-0

6

Mar-

08

Ju

n-0

9

Sep

-10

De

c-1

1

Mar-

13

Ju

n-1

4

Sep

-15

De

c-1

6

Mar-

18

Travel Service Net Balance

Charges of Intellectual's Use Net Balance

Investment Income Net Balance (RHS)

JPY bn JPY bn

40%

50%

60%

70%

80%

90%

100%

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

Japan Germany France

Australia Korea

40%

50%

60%

70%

80%

90%

100%

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17


Australia Korea

0%

20%

40%

60%

80%

100%

120%

140%

160%

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17


Australia Korea

50.0%

55.0%

60.0%

65.0%

70.0%

75.0%

80.0%

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17


Australia Korea

…domestic productivity

remains an issue


12 December 2018 11

In summary, Japan is in many ways a unique economy and society, characterized by:

1. High degree of ethnic homogeneity and relatively egalitarian distribution of income and

wealth;

2. A strong popular consensus that the objective of national policies should be maintenance

of standards of living, rather than ‘chasing the rainbows’;

3. Rapidly deteriorating demographics, which is forcing the country to the outer frontiers of

automation and robotics and finding creative ways of keeping older cohort participation

rates at one of the highest levels amongst developed economies;

4. High spending on R&D, strong portfolio of patents and intellectual property rights (second

only to the US), which is keeping Japan’s complexity indices high, implying a higher than

average prevalence of unique and relatively price inelastic products;

5. Tightly co-ordinated fiscal and monetary policies, which aim to ensure that there are no

panics and confidence in the state and its institutions is maintained.

6. This co-ordination is enhanced by the fact that Japan has never been a true capitalist

economy. Despite protestation to the contrary, BoJ is not effectively an independent

institution, and MITI (or METI, since 2001) still sets parameters for private sector. In that

respect Japan is quite similar to China.

The clear downside of these structural pluses is a lack of conventional capitalist market

efficiencies. Despite several tentative de-regulatory moves, Japan’s labour market remains one of

the most sclerotic amongst developed economies, with sharp differentiation between the full-time,

part-time and casual workforce as well as relatively rigid promotional systems. Recent de-

regulation drives have left bulk of the domestic economy (from agriculture, construction,

transportation to services) largely untouched. Abe’s ‘third arrow’ has never really left the bow, and

we maintain that the deregulatory agenda is highly unlikely to be ever truly embraced. In our view,

the nation would rather wait for passage of time and technology to alter domestic productivity,

rather than confront far more unpalatable aspect of structural reforms. In that respect, Japan is not

different to anyone else, except resistance to reforms is generally much greater in Japan.

Similarly, we believe that domestic hostility towards inbound immigration (i.e. freer immigration has

always been suggested by most economists as the most obvious answer to the country’s

demographic challenges) would remain strong. Equally, we believe that Japanese (unlike, say

many Chinese) would continue to strongly prefer residing in Japan, rather than exploring wider

horizons. This historical cultural exclusiveness, while giving a society its cohesion, also limits

opportunities to tap wider and broader options and markets. As discussed in our prior reviews, the

World Wide Values surveys consistently show that Japanese has the lowest level of trust in

foreigners when compared to other developed nations (10% vs 30%+). Again, even as generations

change, we do not believe this ‘island based’ exclusiveness would weaken much.

Normally, economists would argue that an ageing population, an inability to benefit from inbound

immigration and limitations on interchange of ideas or commercialization of inventions, would

condemn a country to a slow death. However, we continue to strongly believe that rapid

technological evolution is leading to a steady but inexorable decline in returns on labour and

conventional capital, while increasing returns on digital capital. Instead of trying to return factories

to Japan (as the Trump administration is trying to do in the US), Japan is building for the future, by

allowing for rapid proliferation of robotics and automation (and after all, TFP does not mind

whether there is a biological mass attached to a given activity) and strengthening its position in

artificial reality, games and AI. Demographics used to be the 'beating heart’ of economies;

alas, this is increasingly no longer true and while Japan is facing a multitude of challenges,

in our view, demographics is not one of them. The same applies to the importance of societal

homogeneity (rather than Western multiculturalism), which is becoming much more important in a

world that is undergoing jarring transition and upheavals.

Homogeneity,

egalitarian wealth

distribution, social

cohesion, innovation &

BoJ are the keys

while…


12 December 2018 12

What about BoJ and JGBs? We maintain that if Japan were to be a corporate entity, the

Government bonds held by BoJ would have been by now eliminated on consolidation (i.e. it

belongs to the same Government). We believe that the ultimate objective of BoJ’s operations is not

to reflate economy but to eliminate (quietly and over time), the debt burden. While, there is no

doubt that BoJ would need to create some new instruments to enable pricing of long-dated

instruments (such as life policies), it is highly likely that at some stage, investors would wake up to

the fact that 50% of debt essentially no longer exists. In some ways, Japan is actually doing a

‘Debt Jubilee’ (or effective debt forgiveness), which was extensively discussed following the GFC.

While the downside is that zero rates never clear excesses and keep zombie companies

functioning, the upside is that it avoids fracturing societies and economies. In any case, while

Japan was in the past regarded as a unique event (hence, frequent articles like ‘could it happen

here?’ that were written in late 1990s and early 2000s), these days the same forces of

technological disruption and financialization, are driving almost every society towards the

same answer, (i.e. cost of capital can never go up, as economies with low productivity and high

leverage cannot sustain higher rates). Hence, it is not just Japan, but almost everyone (apart from

the least developed economies) that need to debate issues of zero bound rates, dominance of

Central Bank policies, intermingling of fiscal and monetary policies and, yes, debt jubilees.

Japan seem to be now simply ahead of the curve, rather than being an exception to

established rules; and it has far better instruments, historical and societal background to handle

this transition from conventional to unconventional economics.

Fig 40 Real 10Y Bond Yields – all together now…hugging zero bound…

Source: Bloomberg, Macquarie Research, December 2018

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

De

c-9

2

Ja

n-9

4

Feb

-95

Mar-

96

Apr-

97

Ma

y-9

8

Ju

n-9

9

Ju

l-00

Aug

-01

Sep

-02

Oct-

03

No

v-0

4

De

c-0

5

Ja

n-0

7

Feb

-08

Mar-

09

Apr-

10

Ma

y-1

1

Ju

n-1

2

Ju

l-13

Aug

-14

Sep

-15

Oct-

16

No

v-1

7

US Germany Japan UK

Hugging close to zero

…the rest of the world is

converging on Japan’s

model


12 December 2018 13

Modest expectations and high ROE – a good mix

The above constructive view of Japan’s macro factors complements what appear to be reasonably

conservative investor estimates of earnings, attractive multiples and quite robust ROEs.

Unlike most other jurisdictions (such as MSCI US or MSCI EMs), where we have reservations as

to ability of corporates to deliver (near) double-digit growth rates, in the case of Japan, earnings

expectations are generally quite moderate (~3–5%). Also, unlike most other indices, which have

been recently suffering from growth downgrades, MSCI Japan earnings expectations have

generally been quite stable, with upgrades in energy and utilities offset by downgrades in banks

and technology, with net market EPS estimates for March 2020, up by ~2% when compared to

estimates prevailing in December 2017.

Also, over the last eighteen months, Japan’s corporate ROEs have reached the highest levels

since the mid-1980s of ~10% (vs 4–6% ROEs that prevailed through late 1990s and most of

2000s). While the lower ¥ has clearly played a major part in reflating returns, it has also been

driven by a moderate degree of domestic reflation. Clearly the greatest danger facing corporate

ROEs is a potentially sharp ¥ appreciation, if investors indeed agree with us that Japan’s debt

burden might just one day evaporate (through BoJ write-off).

Finally, if we look at 12 months forward PER, MSCI Japan is currently trading at ~12x earnings,

which is somewhat below historical average of 15x while the Price to Book is only 1.1x-1.2x vs

historical average of closer to 1.4x. In other words, not only do EPS estimates seem reasonable,

market valuations are hardly stretched.

Fig 41 MSCI Japan – EPS growth (%) – Indexed to March (2020 estimates imply a broad equivalent to March 2021)

Fig 42 MSCI Japan – Revenue Growth Rates (%) – Indexed to March (2020 estimates imply a broad equivalent to March 2021)

Source: Thomson; Macquarie Research, December 2018 Source: Thomson; Macquarie Research, December 2018

Fig 43 MSCI Japan – Sectoral EPS – March 2019 – (Dec’16=100)

Fig 44 MSCI Japan – Sectoral EPS – March 2020 – (Dec’17=100)


0.0

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2018 EPSg 2019 EPSg 2020 EPSg

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2018 REVg 2019 REVg 2020 REVg

70.0

90.0

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18

MSCI Japan Cons Discretionary

Energy Cons Staples

Banks Tech/IT

Materials T/cm Svs

Indexed EPS for March 2019

95

100

105

110

115

120

De

c-1

7

Ja

n-1

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Feb

-18

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18

Mar-

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v-1

8

No

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8

MSCI Japan Cons Discretionary

Energy Cons Staples

Banks Tech/IT

Materials T/cm Svs

Indexed EPS for March 2020

Corporates remain in

rude health, with high

ROEs, moderate

expectations and

reasonable multiples


12 December 2018 14

Fig 45 Datastream Japan – Trailing ROE (%) – the highest since 1980s

Fig 46 Datastream Japan – Trailing Profit Margins (%) – the highest since 1960s-70s


Fig 47 MSCI Japan – Forward PER (x)

Fig 48 Datastream Japan – Trailing Profit Margins (%) – the highest since 1960s-70s


Thus, barring a sudden ¥ appreciation, we believe that Japan equities are generally offering a

better trade-off than most other markets.

This is particularly so given that as discussed in our 2019 preview (here), the degree of uncertainty

facing US (i.e. divided Congress, Trump, untried Fed), Europe (i.e. European elections, changes at

the ECB) or China (i.e. timing, nature and the impact of any policies designed to reflate local

demand and support growth, conducted amidst attempts to rebuild both structure of economy and

society, compounded by trade war and FDI volatilities). As discussed above, we do not believe that

Japan is likely to significantly change either its macro or Central Bank and monetary stance.

Although it does remain a hostage to global cycles, it also has a vibrant selection of companies in

industries with underlying strong global and local drivers, although unlike consensus, we do not

assume that there would be a significant change in corporate governance.

As in the case of our Asia Ex Japan and Global Portfolios, we believe that the only

consistent way to invest, in what is largely an inconsistent world, is to focus on corporates

able to grow without excessively discounting margins while keeping ROEs at a fairly high

level (~12% or above) and without leveraging the balance sheet. We also believe that Japan

has a number of strong consumer domestic stories that do not rely on reflationary pulse (such as

FMCG, or fast moving consumer goods). Working with our colleagues in Japan while also within

our ‘Quality Sustainable Growth’ framework, we have designed a portfolio of Japanese stocks

that we believe best reflects the strengths of Japan, both external and domestic (see below). Some

stocks that have not quite made the cut, but nevertheless, are our team’s favourites include Rengo

(3941 JP), Mitsubishi Motors (7211 JP), Honda (7267 JP), Suntory (2587 JP) and Kirin (2503 JP).

-4.0

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Japan market - Net margins

0

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MSCI JAPAN-12m fw PER

+ 1 stdev

- 1 stdev

Average

0.8

1.0

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MSCI JAPAN-12m fw PTBV

+ 1 stdev

- 1 stdev

Average

Japan is facing much

lower degree of

uncertainty than either

US, EU or China

We continue to like

domestic and external

sustainability


12 December 2018 15

Fig 49 Japan – ‘Quality Sustainable Growth’ (QSG) Portfolio

Source: Factset, Macquarie Research, December 2018

Although we have never been fans of backward-looking performance justification, nevertheless,

just for the record, the back-testing of this portfolio would have delivered over the last two years in

excess of 42% outperformance, including 16% outperformance YTD.

Fig 50 Japan – QSG vs the Index Fig 51 QSG Portfolio Relative Performance

Source: Factset; MSCI; Macquarie Research, December 2018 Source: Factset; MSCI; Macquarie Research, December 2018

Ticker Company Name Reco.

Market

Cap

(US$M)

Upside/

Downside

(%)

NTM P/EROE

('18E)

Net

debt/

EBITDA

('18E)

EBITDA

Margins

('18E)

Net

Income

adj

CAGR

(17-19E)

7203 JP Toyota Motor Corp. OP 198,559 26% 8.2 11.8 3.8 12.6 -0.6

6758 JP Sony Corporation OP 66,333 32% 12.1 21.0 -1.1 14.0 7.5

9983 JP FAST RETAILING CO., LTD. N/R 55,522 NA 34.1 19.4 -1.7 13.2 19.0

7974 JP Nintendo Co., Ltd. N/R 41,332 NA 16.2 14.2 -3.9 21.1 38.7

6981 JP Murata Manufacturing Co., Ltd. OP 33,171 37% 13.9 14.0 -0.3 24.9 35.1

7741 JP HOYA CORPORATION OP 23,242 15% 20.5 21.6 -1.4 31.1 11.7

8035 JP Tokyo Electron Ltd. OP 21,293 45% 10.6 28.0 -1.0 26.7 -0.9

8113 JP Unicharm Corporation OP 19,931 35% 30.9 14.6 -1.0 18.9 13.6

2267 JP Yakult Honsha Co., Ltd. OP 13,128 21% 34.2 10.3 -0.3 17.1 9.8

6506 JP Yaskawa Electric Corporation OP 7,750 28% 19.6 17.5 -0.1 14.5 0.9

3769 JP GMO Payment Gateway, Inc. OP 4,615 18% 88.4 18.7 -3.5 28.5 35.8

6268 JP Nabtesco Corporation OP 3,032 35% 15.6 10.3 -0.1 11.1 -5.8

Average 40,659 29% 25.4 16.8 -0.9 19.5 13.7

90

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Ja

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Feb

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7

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Sep

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De

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Ja

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Feb

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Mar-

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Apr-

18

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8

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Aug

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Sep

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Oct-

18

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8

Japan QSG MSCI Japan

Rebased PricePerformance(Dec 16 = 100)

90

100

110

120

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140

150

De

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Ja

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7

Feb

-17

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Ju

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Aug

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Sep

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7

De

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Ja

n-1

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Feb

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Mar-

18

Apr-

18

May-1

8

Ju

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Ju

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Aug

-18

Sep

-18

Oct-

18

No

v-1

8

Japan QSG Price Performance relative to MSCI Japan


12 December 2018 16

Appendices

Fig 52 Index performance (local currency, unless stated otherwise), %

Note : Priced as of close of 10th of December 2018 Source: MSCI, Thomson, Macquarie Research, December 2018

Fig 53 Index performance by MSCI country and sector (local currency) – Last three months, %


MSCI Indices - 1W - 1M - 3M - 1Y - 3Y - 5Y YTD Index

MSCI AC Asia ex JP (LC) -4.7 -0.6 -6.5 -11.7 19.4 13.9 -13.9 737

ASXJ Consumer Discretionary -6.2 -0.9 -11.7 -25.9 -5.6 -28.0 -29.0 397

ASXJ Consumer Staples -2.2 1.4 -4.1 -3.7 13.9 18.3 -6.5 535

ASXJ Energy -4.8 -4.3 -8.4 5.5 53.5 -0.6 1.5 721

ASXJ Financials -4.5 -1.4 -2.3 -6.9 20.8 18.7 -10.1 345

ASXJ Health Care -7.4 -7.5 -16.7 -5.5 1.4 37.2 -13.6 963

ASXJ Industrials -3.8 1.0 -2.9 -10.0 -5.2 -12.9 -11.8 149

ASXJ Information Technology -6.8 -1.0 -10.3 -17.7 41.4 52.7 -18.2 449

ASXJ Materials -3.7 -1.8 -8.7 -10.1 30.2 4.4 -14.0 345

ASXJ Utilities -1.5 0.8 -2.5 0.0 9.3 10.3 -0.4 233

ASXJ Telecom Svcs -3.5 1.1 -1.9 -8.8 -10.8 -9.5 -10.8 122MSCI AC ASIA EX JP U$ -5.2 -0.3 -6.2 -13.7 20.7 7.2 -16.4 596

MSCI CHINA U$ -5.9 1.2 -3.9 -15.7 22.6 11.1 -18.2 72MSCI HONG KONG U$ -4.2 2.6 -1.6 -8.2 16.3 14.4 -11.7 10,906MSCI INDIA U$ -5.5 -0.7 -8.9 -10.6 20.2 27.6 -14.2 524MSCI INDONESIA U$ -2.2 5.2 10.5 -7.6 26.8 18.4 -12.7 799MSCI KOREA U$ -5.4 -3.0 -10.1 -20.3 21.7 -2.4 -22.2 431MSCI MALAYSIA (EM) U$ -2.2 -2.4 -8.9 -6.0 2.2 -33.1 -11.0 342MSCI PHILIPPINES U$ -3.3 6.2 -1.3 -15.3 -5.7 4.5 -19.2 489MSCI SINGAPORE U$ -4.3 -0.6 -1.9 -12.6 10.2 -11.8 -13.5 3,589MSCI TAIWAN U$ -6.1 -3.9 -13.0 -11.1 24.0 13.6 -13.5 326MSCI THAILAND U$ -1.8 0.1 -1.4 -0.5 51.3 20.5 -4.0 456

MSCI China -5.9 1.0 -4.2 -15.6 23.5 11.9 -18.2 73

MSCI Hong Kong -4.2 2.4 -2.1 -8.1 17.2 15.3 -11.8 15,339

MSCI India -4.1 -2.1 -10.2 -1.0 28.5 49.2 -4.1 1,214

MSCI Indonesia -0.1 4.3 8.2 -0.7 32.4 43.8 -6.3 7,044

MSCI Korea -4.1 -3.1 -10.2 -17.8 16.1 4.5 -18.2 613

MSCI Malaysia -2.1 -2.6 -8.2 -4.0 0.0 -12.9 -8.3 574

MSCI Philippines -2.4 5.9 -3.3 -11.5 5.5 24.5 -14.5 1,241

MSCI Singapore -3.9 -0.9 -2.3 -11.2 8.1 -3.1 -11.1 1,603

MSCI Taiwan -5.7 -3.7 -12.9 -8.5 16.6 18.7 -10.3 353

MSCI Thailand -1.7 -0.6 -1.5 -0.1 37.9 23.0 -3.4 599

MSCI USA -5.5 -5.1 -8.5 -0.6 28.2 45.6 -1.4 2,509

MSCI AC WORLD U$ -5.5 -4.9 -8.4 -6.7 17.7 17.9 -8.3 470

MSCI EM U$ -5.3 -1.4 -4.8 -13.3 22.0 -4.9 -16.9 963

MSCI WORLD U$ (Dev) -5.5 -5.3 -8.9 -5.8 17.4 21.0 -7.2 1,953

MSCI EM ASIA U$ -5.4 -0.6 -6.9 -14.5 22.1 7.5 -17.2 486

MSCI WORLD EX JP ($) -5.5 -5.5 -9.0 -5.4 18.2 21.9 -6.7 1,976

MSCI EUROPE U$ -5.9 -7.0 -11.0 -15.5 -2.4 -11.9 -17.3 1,486

MSCI EMU U$ -6.2 -6.9 -12.4 -18.2 0.6 -8.3 -18.5 173

MSCI AC Asia ex JP

AC

Asia

ex JP

China HK India Indo Korea Mal Phils Sing TW Thai EMG World

(Dev)

Japan

AC

World

MSCI Country Index -6.5 -4.2 -2.1 -10.2 8.2 -10.2 -8.2 -3.3 -2.3 -12.9 -1.5 -5.7 -8.2 -5.4 -8.0

Cons. Disc -11.7 -11.7 -4.4 -18.4 8.1 -13.7 -33.2 4.5 -1.8 -3.5 -0.6 -11.8 -9.3 -4.7 -9.5

Staples -4.1 -9.5 1.6 -1.9 9.2 -6.8 -6.3 -16.3 0.2 -9.5 3.6 -5.2 -1.8 0.5 -2.1

Energy -8.4 -6.9 NA -12.8 -14.6 -8.3 -5.7 0.0 0.0 -9.2 -2.5 -1.9 -11.6 -12.1 -10.3

Financials -2.3 -0.6 -2.6 -7.7 12.2 -6.6 -2.3 2.4 -2.3 -4.8 -4.4 0.3 -11.3 -6.2 -9.6

Banks -3.3 -1.5 -14.8 -7.4 12.2 -8.6 -2.3 6.6 -2.3 -4.3 -4.4 0.9 -12.7 -8.3 -10.0

Real Estate -0.8 -0.7 0.0 NA 16.5 NA -15.6 -2.6 -1.6 -0.5 -7.6 -2.5 -0.5 4.9 -0.7

Health Care -16.7 -23.4 NA -19.8 29.0 -12.0 -3.5 NA 0.0 -22.0 4.2 -16.6 -2.5 -5.5 -2.9

Industrials -2.9 1.4 -4.4 -1.7 0.4 -6.0 -12.1 -6.9 -2.3 -2.1 3.2 -2.6 -11.7 -4.8 -11.2

IT -10.3 -6.4 -4.7 -7.4 NA -12.3 -31.9 0.0 -12.9 -17.2 -0.7 -10.4 -11.7 -11.0 -11.6

Materials -8.7 -6.3 0.0 -10.8 -2.5 -10.5 -2.3 0.0 NA -10.1 -0.9 -9.5 -10.4 -9.3 -10.2

Utilities -2.5 1.3 -1.8 -11.6 3.5 4.0 -10.9 -5.8 NA NA -1.0 1.0 2.1 9.2 2.0

Telecom Services -1.9 0.2 17.0 -22.9 6.6 4.9 -9.8 -11.1 -2.1 -1.0 -8.9 -2.2 -0.8 -10.5 -1.0


12 December 2018 17

Fig 54 Valuations – Asia ex JP and key comps


Fig 55 Macquarie – Country allocation tilts

Source: Macquarie Research, December 2018

Avg since 2010

MSCI Indices PER P/B EPS gr ROE DY PER P/B ROE DY PER P/B

MSCI AC Asia ex JP 11.2 1.3 9.0 11.7% 3.1% 12.0 1.6 12.7% 2.9% 11.8 1.5

ASXJ Consumer Discretionary 13.1 1.4 18.4 10.5% 2.5% 11.6 1.8 14.8% 2.3% 12.0 1.7

ASXJ Consumer Staples 21.6 2.8 8.4 13.0% 2.2% 17.0 2.7 15.0% 2.3% 19.7 2.8

ASXJ Energy 9.6 1.2 10.4 12.1% 4.4% 10.2 1.6 13.8% 3.2% 10.7 1.3

ASXJ Financials 8.9 1.0 11.2 11.7% 3.8% 11.6 1.3 11.4% 3.3% 10.1 1.2

ASXJ Health Care 25.7 3.4 19.4 13.2% 0.9% 19.7 3.3 15.3% 1.1% 22.7 3.3

ASXJ Industrials 10.6 1.0 11.5 9.1% 2.8% 13.0 1.4 10.4% 2.5% 12.6 1.2

ASXJ Information Technology 12.5 2.0 3.3 16.1% 2.3% 13.3 2.0 16.0% 2.1% 12.6 2.0

ASXJ Materials 9.6 1.0 4.1 10.9% 3.9% 10.6 1.3 12.4% 3.2% 11.8 1.3

ASXJ Utilities 13.6 1.2 16.1 9.0% 3.4% 12.5 1.4 10.6% 3.3% 12.9 1.4

ASXJ Telecommunication Services 16.0 1.5 3.4 9.4% 4.1% 13.4 2.0 14.3% 4.0% 14.2 1.8

MSCI China 10.5 1.4 14.1 13.2% 2.8% 11.6 1.7 14.5% 2.9% 10.5 1.5

MSCI Hong Kong 13.6 1.1 9.3 8.1% 3.5% 15.4 1.4 8.5% 3.2% 14.9 1.2

MSCI India 17.5 2.5 22.3 14.5% 1.7% 14.9 2.7 16.2% 1.6% 15.9 2.5

MSCI Indonesia 14.5 2.4 11.7 16.3% 2.9% 11.9 2.8 20.4% 3.1% 14.2 2.8

MSCI Korea 7.8 0.9 2.6 11.0% 2.8% 9.3 1.2 12.1% 1.7% 9.2 1.1

MSCI Malaysia 15.5 1.5 5.4 9.8% 3.4% 14.6 1.8 12.3% 3.5% 15.1 1.8

MSCI Philippines 15.9 1.9 11.9 11.8% 1.8% 15.4 2.2 14.0% 2.4% 17.1 2.5

MSCI Singapore 11.7 1.1 6.8 9.7% 4.7% 14.0 1.5 10.5% 3.7% 13.2 1.3

MSCI Taiwan 12.6 1.5 1.4 12.2% 4.8% 13.9 1.7 13.0% 3.9% 13.3 1.7

MSCI Thailand 13.7 1.8 6.4 12.8% 3.3% 11.4 1.8 15.5% 3.7% 12.6 1.9

MSCI EMG 10.6 1.3 9.9 12.7% 3.4% 10.9 1.6 14.0% 3.0% 11.0 1.4

MSCI World (Dev) 14.5 2.1 8.6 14.7% 2.7% 14.8 1.9 13.6% 2.7% 14.3 1.9

MSCI AC World (All) 13.9 2.0 8.8 14.4% 2.8% 14.4 1.9 13.6% 2.8% 13.8 1.8

MSCI Japan 12.1 1.2 3.4 9.6% 2.5% 16.4 1.3 8.6% 1.8% 13.7 1.1

MSCI USA 15.9 3.0 9.6 18.6% 2.1% 15.5 2.4 15.8% 2.1% 15.1 2.4

MSCI Australia 14.1 1.8 4.2 12.5% 5.4% 14.2 2.0 13.9% 4.7% 14.0 1.8

12 Month forward estimates LT Average (12M forward ests)

-3 -2 -1 0 1 2 3

China

India

Korea

Taiwan

Singapore

Hong Kong

Malaysia

Philippines

Thailand

Indonesia


12 December 2018 18

Recent Equity Strategy Research

What caught my eye? v.101 – In praise of ‘draining the swamp’ 4 Dec 2018 From Bear to Bull and Back – Neutral Rate, PMIs and ‘jaw-to-jaw 4 Dec 2018 Craftsmen in a World of Factories – Do we still need fundamentals? 22 Nov 2018 Rights, Wrongs & Returns 2019 – Tragedy, Farce or Both? 21 Nov 2018 Between Blue and Red Waves – Populism survived and it is just the beginning 7 Nov 2018 Living in a Matrix – Flashes in the sky and what drives them 31 Oct 2018 What caught my eye? v.100 – Retrospective 15 Oct 2018 EM bond markets contagion – Limited thus far; next tremor might be worse 12 Oct 2018 Technology sell-off and cost of capital – What would you fund? The future or the past? 10 Oct 2018 China Fears and Minsky Moments – It will never be a conventional free economy 10 Oct 2018 Macquarie Global Strategy Presentation – A twilight world of trade wars & recessions 9 Oct 2018 What to look for as volatilities rise? – Inflation and Fed’s responses are the key 8 Oct 2018 EMs in the crosshairs – Between war games, fake news and bonds 5 Oct 2018 Global Liquidity Eroding – But nothing is breaking yet 28 Sep 2018 What caught my eye? v.99 – China: competing, complementing, innovating 27 Sep 2018 Rising regulatory & political burden – How will corporates respond? 12 Sep 2018 Where would the next shoe drop? – How much should we worry about India? 7 Sep 2018 What caught my eye? v.98 – Demographic tsunami: where would they go? 5 Sep 2018 What happens when all doors are closed? – Catching falling knives & EM contagion 5 Sep 2018 Towards Singularity – Investment Rules for Disrupted World 20 Aug 2018 What can kill SPX? Any relief for EMs? – Watch trade & US$ blowback for signals 17 Aug 2018 The world remains on US$ leash – Triffin paradox, forecasting & Turkey 15 Aug 2018 What caught my eye? v.97 The centre cannot hold; ‘going to mattresses’ 14 Aug 2018 Emerging markets at crossroads – Are politics & economics on a suicide course? 13 Aug 2018 Are higher savings good news? Either it is an error or it might be a problem 3 Aug 2018 What caught my eye? v.96 – The curious case of India vs Philippines 2 Aug 2018 Corporates – innovators vs just average – All winnings go to the winner; it won’t stop 18 Jul 2018 Rights, Wrongs & Returns – A twilight world of trade wars & recessions 17 Jul 2018 Trade Wars & Profits – Have we seen the peak of corporate returns? 9 Jul 2018 EM Equities – may be a pleasant summer How likely is a short-term dead-cat bounce? 29 Jun 2018 The extreme left meets extreme right – How do markets react to exceptional events? 28 Jun 2018 What caught my eye? v.95 – On Labour, Wages, CEOs & Capital 26 Jun 2018 Should investors worry about recession? – It all depends on liquidity & China 26 Jun 2018 Trump, Kim or Powell? - Liquidity, inflation & China; ignore the rest 20 Jun 2018 Are we running out of policy tools? Slaves of some defunct economist 20 Jun 2018 What caught my eye? v.94 – What if China suddenly disappeared? 5 June 2018 Eurozone contagion – Prisons are quiet until inmates riot 29 May 2018 What caught my eye? v.93 – Investment Purgatory: equities flutter & wait 29 May 2018 When should one nullify elections? – On Huey, ‘smoke filled rooms’ and Italy 28 May 2018 Identity Politics, economics & Markets – Why identity is almost irreversible? 15 May 2018 What caught my eye? v.92 – Trade deals need a fall guy. Who will it be? 15 May 2018 What caught my eye? v.91 – Indonesia – secular, cyclical or neither? 8 May 2018 US$ and its discontents – Liquidity, CA deficits, deflation & EMs 7 May 2018 What caught my eye? v.90 – Globalization and nations: can they coexist? 23 Apr 2018 Rights, Wrongs & Returns – Impotence of noise; importance of liquidity 18 Apr 2018 The tech sell-off – what happened to our portfolios? 3 Apr 2018 Are canaries still singing? – Rising plumbing pressures 29 Mar 2018 The end of liberal order – de-globalization drift; but no wars, yet 27 Mar 2018 What caught my eye? v.89 – What do EM market internals tell us? 16 Mar 2018 Volatilities & Contagion – All Quiet on the Western Front 12 Mar 2018 What caught my eye? v.88 – Bukharin, NEP, Hayek, China & AI 9 Mar 2018 Tariffs, Elections & CEOs – Unorthodox minds in disrupted world 5 Mar 2018 What caught my eye? v.87 – Inflationary note in a deflationary tune 21 Feb 2018

Importance of ironclad laws – US administration & sectoral balances 13 Feb 2018 CBs & asset-based world – can we survive a return to normality? 6 Feb 2018 Macro contagion risks – Is it a ‘flutter’ or a deadly heart attack? 5 Feb 2018 Consumer of last resort – Music, deficits, dissaving and low US$ 29 Jan 2018 What caught my eye? v.86 – Volatilities: from masters to slaves 26 Jan 2018 Global Tech Giants – Frogs in boiling water? 22 Jan 2018 Why history matters – Henry Ford, dot.com & bitcoins 11 Jan 2018 Break with the past? – Bonds: The king is dead; long live the king 10 Jan 2018 What caught my eye? v.85 – EMs – divergence is likely to deepen 8 Jan 2018 Slow burn default – Mean reversion is not coming back 19 Dec 2017 What caught my eye? v.84 – China – Perception & Reality 7 Dec 201 What caught my eye? v.83 – The agonizing death of corporates, 21 Nov 2017 Rights, Wrongs & Returns, 2018 – Year of choices & consequences 14 Nov 2017 Portfolio update – out with the old, in with the new 1 Nov 2017


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CBs vs. markets – Can CBs shift the entire yield curve? 27th Oct 2017 Comrades-in-arms – Parallel but different lives 27 Oct 2017 What caught my eye? v.82 – Looking through India’s fog 13 Oct 2017 Ready for Battle - Stocks to watch this earnings season 10 Oct 2017 World without risk - Loose liquidity and no risks anywhere 9 Oct 2017 US Policy landscape - Much ado about nothing 28 Sep 2017 What caught my eye? v.81 - Between Bitcoin, seashells and US$ 28 Sep 2017 What caught my eye? v.80 - Japan Debt Mountain: does it matter? 22 Sep 2017 Why equities are different - The old value vs. growth dilemma 14 Sep 2017 What caught my eye? v.79 - Army mutiny & default – no problems 8 Sep 2017 Korea et al - Rational investing in an irrational world 5 Sep 2017 Asia MicroStrategy - 2Q/17 earnings – what did we learn? 4 Sep 2017 Undying desire for normality - Travel notes: need to replace idols 18 August 2017 Asia MicroStrategy - Most loved and hated stocks in Asia ex (II) 11 August 2017 Technology & bubbles - Would you buy tech on any pullback? 1 August 2017 What caught my eye? v.78 - How long would tranquil autumn last? 24 July 2017 Rights, Wrongs & Returns - CBs – can slaves become masters? 18 July 2017 Ready for Battle - Stocks to watch this earnings season 10 July 2017 Cambrian explosion - Birth of the new; extinction of the old 10 July 2017 What caught my eye? v.77 - EMs – calm waters or storm ahead? 29 June 2017 Impossibility of tightening - Opioids – prescribed by CBs & China 21 June 2017 One Belt One Road (OBOR) - Selfish yet enlightened Marshall Plan 15 June 2017 What caught my eye? v.76 - The world of no wages 14 June 2017 Thematic Portfolios - On Bread & Circuses 9 June 2017 Asia MicroStrategy - What will corporates do with $2.5trn? 8 June 2017 The world’s largest industry - Capital manufacturing Capital 22 May 2017 What caught my eye? v.75 - India: is it more than just liquidity? 12 May 2017 Who is driving reflation? - China is out; it is all up to the US 5 May 2017 Thematics Portfolio - Why Amazon and not Apple? 24 April 2017 Ready for Battle - Stocks to watch this earnings season 20 April 2017 Rights, Wrongs & Returns - 2H’17 – Clash of the Titans 11 April 2017 What caught my eye? v.74 - China – Atlas holding up the sky 24 March 2017 Money rollercoaster - Dumb money, smart money and AI 3 March 2017 What caught my eye? v.73 - Is higher uncertainty = higher growth? 2 March 2017 Asia MicroStrategy - Earnings recovery. Is it sustainable? 23 Feb 2017 ‘Danse Macabre’ - Strong leaders, US$ and gold 21 Feb 2017 Bond vs. Equity markets - Little reflation in one; a lot in another 21 Feb 2017 What caught my eye? v.72 - Surfing debt wave. Don’t look down! 16 Feb 2017 Reflationary theme - Is it peaking? We think so 16 Feb 2017 What caught my eye? v.71 - Investing in a policy & twitter blizzard 8 Feb 2017 What caught my eye? v.70 - Eurozone’s Achilles’ heel 19 Jan 2017 Ready for Battle - Stocks to watch this earnings season 12 Jan 2017 What caught my eye? v.69 - Is China on the wrong side of history? 5 Jan 2017 What caught my eye? v.68 - Is it time for quality, growth or value? 20 December 2016 Fed’s dilemmas - Binary outcomes and fat tails 15 December 2016 What caught my eye? v.67 - Populism = Stagflation & Poor return 7 December 2016 Strategy for the New World - Changing Landscape & Investment Rules 6 Dec 2016 Asia MicroStrategy - The Yield curveball 24 November 2016 Rights, Wrongs & Returns - 2017– State reflation or stagflation? 15 November 2016 Dawn of a new age - Populism rules. Status quo – R.I.P. 9 November 2016 DXY & Markets - Has the link been broken? 3 November 2016 What caught my eye? v.66 - Is it reflation, stagflation or twilight? 27 October 2016 Ready for Battle - Stocks to watch this earnings season 12 Oct 2016 What caught my eye? v.65 - Is China ‘a shining city upon a hill’? 7 October 2016 MicroStrategy - Buy & sell side: Most loved & hated stocks 26 September 2016 Markets & US elections - Donald or Hillary, does it matter? 13 September 2016 What caught my eye? v.64 - Could strong DXY be good for EMs? 9 September 2016 In JFK’s footsteps - Mars, communism, fascism or war 1 September 2016 What caught my eye? v.63 - Deconstructing SPX – mind the GAAP 25 August 2016 Twilight - where to now? - ‘Damned Volcker’ and equities 16 August 2016 EM Equities ‘Goldilocks’ - It is all about US10Y & DXY 12 August 2016 What caught my eye? v.62 - Thailand & coups – any benefit? 11 August 2016 Policy cross-roads - Is it the end of monetary activism? 1 August 2016 What caught my eye? v.61 - ‘Lumpenproletariat’ & deglobalisation 20 July 2016 Rights, Wrongs & Returns - 2H16 – Investment Twilight zone 15 July 2016 Investment twilight - Between ignorance & confusion 12 July 2016 Ready for Battle - Macquarie earnings survivors’ guide 6 July 2016 MicroStrategy - Beyond Brexit, back to Asian fundamentals; where to from here? 29 June 2016 Brexit et al - It is all about 2nd derivatives & CBs 24 June 2016 What caught my eye? v.60 - Parallel lives: Japan vs. China 23 June 2016 What caught my eye? v.59 - In praise of Thematics 7 June 2016


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What caught my eye? v.58 - Divergence, convergence & confusion 24 May 2016 What caught my eye? v.57 - Portfolios: The case of less is more 17 May 2016 What caught my eye? v.56 - Capital – Time for a vegetarian diet? 11 May 2016 What caught my eye? v.55 - Why are we staying in China & India? 29 April 2016 Ready for Battle - Macquarie earnings survivors’ guide 21 April 2016 Rights, Wrongs & Returns - Year of Living dangerously – sequel 13 April 2016 Central Banks & Markets - Mutually assured destruction 31 March 2016 Global Travel Notes - The blind leading the blind 29 March 2016 MicroStrategy - Earnings season – A letdown so far but there is a silver lining 22 March 2016 What caught my eye? v.54 - Negative rates and the war on savers 2 March 2016 What caught my eye? v.53 - Philippines shelter; CBs calling E.T 23 February 2016 Is it a policy dead-end? - Consistency in an inconsistent world 11 February 2016 What caught my eye? v.52 - Launching global portfolios 4 February 2016 Central Banks - Why insistence on failed policies? 1 February 2016 China’s hard landing - Has it already happened? 27 January 2016 What caught my eye? v.51 - Bulls, Bears and low rates 22 January 2016 What caught my eye? v.50 - The Fed and the need for redemption 11 January 2016 MicroStrategy – Growth it is - Five reasons we prefer Growth over Value 8 January 2016 China choices – narrowing - Between a rock and a hard place 7 January 2016 What caught my eye? v.49 - China’s savings dilemma 4 January 2016 Fed hikes. What now? - Implications for EM equities 17 December 2015 20 YEARS IN ASIA 14 December 2015 Is it Bear Stearns moment? - Year of living dangerously, part II 14 December 2015 Rights, Wrongs & Returns - 2016 - Year of living dangerously 25 November 2015 Policy cross-currents - What would unhinge PBoC? 12 November 2015 Bihar dreaming - On impossibility of reforms 9 November 2015 What caught my eye? v.48- EMs – downside to the upside, 3 November 2015 What caught my eye? v.47- The more they do; the worse it gets, 27 October 2015 What caught my eye? v.46-Equities – irrational exuberance?, 8 October 2015 Time for a policy U-turn? - Back to the future: British Leyland, 18 September 2015 What caught my eye? v.45 - Today is more insidious than 1997, 16 September 2015 Old Friend Deflation is Back - From traders to shareholders, 25 August 2015 EM vs DM Equities - What would the average opinion say?, 20 August 2015 Deflators of the world unite - Impact on the US & Global PPIs, 17 August 2015 China’s dilemma - Between a rock and a hard place, 13 August 2015 Return of deflationary vortex - Commodities – canary in a coalmine?, 10 August 2015 What caught my eye? v.44 - Barbarians at the gate, 5 August 2015 China’s policy response - How different is it to G4 economies?, 20 July 2015 Rights, Wrongs & Returns - 2H–Falling knives & deflating bubbles, 13 July 2015 Are dominos finally falling? - Greece, Puerto Rico, China, 6 July 2015 What caught my eye? v.43 - Why consumer & business reticence?, 29 June 2015 China drama & Greek farce - Are CBs at the end of the road?, 29 June 2015 What caught my eye? v.42 - Resisting China; Asia ex earnings, 17 June 2015 Trade & Cyclicality - Stagnation in both = lower yields, 28 May 2015 What caught my eye? v.41 - China & Global Manufacturing, 27 May 2015 What caught my eye? v.40 - CBs vs deflation: will liquidity win?, 8 May 2015 What caught my eye? v.39 - China & Indonesia: Binary outcomes, 29 April 2015 What caught my eye? v.38 - When size does not matter, 13 April 2015 Rights, Wrongs & Returns - 2Q-3Q’15 - The Hall of Mirrors, 27 March 2015 Global Liquidity Watch - Return of Greenspan’s conundrum?, 10 March 2015 What caught my eye? v.37 - India hope is still intact; travel notes, 5 March 2015 Chasing dividends - No mean reversion = desire for yield, 13 Feb 2015 What caught my eye? v.36 - Secular stagnation & four horsemen, 6 Feb 2015 Global liquidity watch - Liquidity tight but should improve, 27 Jan 2015 What caught my eye? v.35 - Focus on Thailand; CBs’ effectiveness, 26 Jan 2015 What caught my eye? v.34 - Trade & Flow watch; A vs H shares, 8 Jan 2015 Is deflation almost here? - What do DXY & bonds tell us, 6 Jan 2015 Global contagion risks - Commodities: canary in a coal mine?, 17 Dec 2014 China A retail exuberance - Damned if you do and damned if you don’t, 9 Dec 2014 Global Liquidity Watch - Eroded in 3Q’14 & Oct/Nov, 8 Dec 2014 Rights, Wrongs & Returns - 2015 preview: the “known unknowns”, 2 Dec 2014 How exposed is Korea? - Yen “doomsday machine”, 17 November 2014 What caught my eye? v. 33 - Currency wars & their discontents, 13 November 2014 What caught my eye? v.32 - On social upheavals, schools & robots, 30 October 2014 What caught my eye? v.31 - Is China in a liquidity trap? EM risks, 16 October 2014 What caught my eye? v.30 - EM vulnerabilities; U/W Indonesia, 9 October 2014 What caught my eye? v.29 - China’s city vs global city, 18 September 2014 What caught my eye? v.28 - Unstoppable China; EM equity rally, 9 September 2014 Global Liquidity - Most measures are looking better, 21 August 2014 ASEAN at the crossroads - Complex choices; uncertain outcomes, 18 August 2014 Phils – Fading optimism - ST concerns overshadow LT story, 31 July 2014


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What caught my eye? v.27 - Importance of Trust; China’s rerating, 29 July 2014 Trade – Waiting for Godot - Small pick-up but no robust cyclicality, 18 July 2014 Rights, Wrongs & Returns - Higher rates or perhaps no rates, 15 July 2014 What caught my eye? v.26 - Oil, geopolitics & family formation, 3 July 2014 What caught my eye? v.25 - Value - many ways to skin a cat, 23 June 2014 What caught my eye? v.24 - Financial stability & catch 22, 13 June 2014 What caught my eye? v.23 - Reforms: who will & who will not, 30 May 2014 What caught my eye? v.22 - Upgrades and stagflations, 21 May 2014 Coups & Martial laws - Not necessarily a bad choice, 20 May 2014 What caught my eye? v.21 - China tourism; Portfolio update, 12 May 2014 What does FIC market tell equity investors? - All quiet on the Western front, 9 May 2014 What caught my eye? v.20 - Investments & geopolitical risks, 29 April 2014 What caught my eye? v.19 - Liquidity in its various forms, 16 April 2014 Rights, Wrongs & Returns - Policy errors, cyclicality & EM volatility, 28 March 2014 FOMC – Impact on EMs - Higher US$, rates and lower demand, 20 March 2014 Difficult case of Indonesia - Euphoria vs. terms of trade & liquidity, 17 March 2014 What caught my eye? v.18 - Is China unravelling? Not Yet, 11 March 2014 “Each unhappy family is unhappy in its own way” - Ukraine, Thailand, Argentina, et al, 3 March 2014 DM vs. EM push & pull - Beware what you wish for, 26 February 2014 Bond Yields & Equities - The question of foreign demand, 24 February 2014 What caught my eye? v.17 - Is the Philippines for real?, 24 February 2014 What caught my eye? v.16 - Third industrial revolution & its impact, 12 February 2014 What caught my eye? v.15 - Investment Cycles & Funds Flows, 17 January 2014 Liquidity trap vs. Stagflation - China vs India – tough choice, 15 January 2014 What caught my eye? v.14 - Would Indian corporates invest?, 6 January 2014 Tapering is on, so is the put - What is likely to happen to volatilities?, 19 December 2013 Investment Outlook – 2014 - “Out with the old and in with the new” Is it 1998 or 1999 – Buy all or Sell all?, 11 December 2013 What caught my eye? v.13 - China's savings conundrum & Plenum, 25 November 2013 What caught my eye? V.12- Hardware vs software; China's "divide & conquer” reform agenda?, 6 November 2013 What caught my eye? v.11 - Leading indicators and “blind alleys”, 28 October 2013 What caught my eye? v.10 - Corporate leverage – how much of a problem?, 3 October 2013 Asia Strategy - When you rely on asset bubbles, what else do you do?, 19 September 2013 What caught my eye? v.9 - Rmb: How exposed is China?, 18 September 2013 What caught my eye? v.8 - In and out of “shadows”, 6 September 2013 What caught my eye? v.7 - If something cannot go on forever, it will stop, 22 August 2013 ASEAN 4 – risks & returns - Kaleidoscope of themes, 16 August 2013 What caught my eye? v.6 - China industrial sector – the Good, the Bad and the Ugly, 31 July 2013 Reviewing Tactical Portfolio - Tough choices: damned if you do and damned if you don't in a slowing world, 10 July 2013 What caught my eye? v.5 - Liquidity – receding tide, 5 July 2013 What caught my eye? v.4 - Central Bank’s “chicken run”, 27 June 2013 What caught my eye? v.3 - QEs to eternity whether successful or not, 12 June 2013 What caught my eye? v.2 - Korea - is China or Japan a greater threat?, 29 May 2013 What caught my eye? - Inflation falling everywhere, 22 May 2013 Rights, Wrongs & Returns - Bears and the Investment Clock, 24 April 2013 DXY rises and Yen falls - The pincer movement for EM equities, 8 April 2013 APAC – Competitive Edge - Separating winners from losers, 21 March 2013

Walk on the wild side - Macro threats - what, if and when 3 March 2013


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Important disclosures:

Recommendation definitions

Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield, which is currently around 9%.

Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Mazi Macquarie – South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie - Canada Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return

Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition*

This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions

All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 30 September 2018

AU/NZ Asia RSA USA CA EUR Outperform 51.56% 59.51% 45.05% 46.88% 67.86% 46.70% (for global coverage by Macquarie, 3.70% of stocks followed are investment banking clients)

Neutral 33.20% 28.92% 37.36% 47.70% 25.00% 42.73% (for global coverage by Macquarie, 2.04% of stocks followed are investment banking clients)

Underperform 15.23% 11.57% 17.58% 5.42% 7.14% 10.57% (for global coverage by Macquarie, 0.47% of stocks followed are investment banking clients)

Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/research/disclosures.

Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Limited (MGL) total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited ABN 58 002 832 126, AFSL 238947, a Participant of the ASX and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Wealth Management, a division of Macquarie Equities Limited ABN 41 002 574 923 AFSL 237504 ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited (“MENZ”) an NZX Firm. Macquarie Private Wealth’s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN 46 008 583 542, AFSL No. 237502) (“MBL”) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act 1989. Apart from Macquarie Bank Limited ABN 46 008 583 542 (MBL), any MGL subsidiary noted in this research, , is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary’s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research contains general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return e-mail and delete the document. We do not guarantee the integrity of any e-mails or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group‘s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures © Macquarie Group

This publication was disseminated on 12 December 2018 at 07:13 UTC.

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