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Japan stock market sell-off is a temporary setback

Japan's stock market has suffered a temporary setback. The country's equity indices have dropped more than 10 per cent this year in local currency terms. With the central bank on standby for more easing, however, Japanese stocks should benefit from home support.

After last year's Abenomics-inspired rally, investors were always likely to pause for breath. But the correction has been more dramatic than many expected. The Topix index is down almost 11 per cent so far this year, while the Nikkei 225 benchmark has dropped almost 12 per cent in Japanese yen terms. That's worse than every other major stock market except Russia.

The latest casualty is Japan Display, the smartphone screen maker which has just completed an initial public offering (IPO). Its shares fell 16 per cent below their IPO price on the first day of trading on March 19.

International and domestic factors are both to blame. The selloff in emerging markets and concerns about China's economy have dented growth expectations and prompted investors to seek safe havens like Japanese government bonds. The Japanese yen, whose slide in 2013 mirrored the stock market's rise, has strengthened by almost four per cent against the US dollar so far this year. On the home front, investors are worried about the economic impact of the three percentage point increase in Japan's sales tax, which takes effect in April.

Nevertheless, there are good reasons to believe the slump won't last. First, valuations are undemanding. Japanese stocks trade on a lower multiple of expected 2014 earnings than their US counterparts, according to analysts at Nomura, and are pricing in little or no profit growth this year.

Meanwhile, the government is still campaigning to force Japan's large pension funds to reduce their outsized holdings of government bonds and shift into other assets, like equities. And, if the economy does falter, the Bank of Japan is widely expected to expand its asset-purchase programme - possibly even by buying stocks directly.

Rightly or wrongly, the administration of Prime Minister Shinzo Abe seems to view the stock market as a barometer of Japan's economic revival. As long as Abenomics remains on track, the stock market setback is likely to prove short-lived.