Musha Research Commentary

27 February 2024

S\
Strategy
Bulletin (No. 350)

Record-high, reasonable stock prices will take off thanks to amajor revival of the high-tech industry!
～The key is Taiwan-Japan industrial cooperation～Q) The Nikkei 225 reached an all-time high last weekend on February 22.
Musha Research has been saying that it will easily exceed 40,000 yen thisyear. What does this all-time high mean and what will happen next?
A) Stock prices are the leading indicator of the economy. The fact that these havereached new highs can be considered the start of a new era and new prosperity forJapan. This is not the peak of the climb. Rather, a spectacular rise in stock prices isabout to begin. Perhaps soon it will reach 50,000 or 60,000, and within five to ten
years it could reach 100,000 yen. With the highest price, market participants nolonger have a yardstick by which to measure a reasonable share price.

Q) How do you measure a reasonable stock price? How does Musha
Research calculate it?
A) For the 10 years since the advent of Abenomics in 2013, the PER of the Nikkei
225 has ranged between 12 and 18 times. The middle value of 15 times (earnings
yield of 6.7%) is a reasonable stock price based on the consensus. If this is the case,the reasonable share price would be 40,000 yen, based on this year's forecasted
EPS of 2,500 yen. However, reasonable P/E ratios have changed significantly
throughout history. Over the long term, the appropriate P/E ratio for both Japan andthe U.S. may be "the same level as the yield on long-term government bonds.
Figure 1 and 2 show that the spread between earnings yields and government bondyields in Japan and the U.S. rose sharply during the period of risk aversion following
the Great Depression and the bursting of the bubble economy, and then declined as
market sentiment recovered, remaining negative when risk-taking strengthened. In
the case of the U.S., the large spread that existed immediately after the GFC has
almost disappeared, and the yield on long-term government bonds is now at the levelof "earnings yield = yield on long-term government bonds,". The Fed used to
calculate a fair value model in which "earnings yield on equity = yield on long-term
government bonds,” and the U.S. is now back there.
In Japan, the yield on Japanese equities was consistently lower than the yield on
bonds during the period of strong risk-taking from the 1970s to the 1990s. In the
2000s, however, risk aversion became more serious, and now, as in the U.S.
immediately after the Great Depression, earnings yields are extremely high,exceeding yields on government bonds. As market sentiment improves, yields onstocks will decline toward the level of yields on long-term government bonds, as in
the U.S., and at some point, they will probably reach an equilibrium level where equity
yields = yields on long-term government bonds. Let us assume that the long-term
interest rate in Japan rises to 3% when 2% inflation takes hold and the BOJ's ultraeasy monetary policy comes to an end. Then, earnings yield of 3% and a P/E ratioof 33 times would be appropriate. In this way, even with the current corporate
earnings (EPS), a reasonable stock price would be justified at the level of 80,000 yen
for the Nikkei average. If the Nikkei Stock Average breaks through the all-time highs,
and the market throws away its frozen market price scale, Japanese stocks may soar
like a kite with a broken string. The Nikkei average of 100,000 yen may not be a
distant future, but a reality that is there now.

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Musha Research Co., Ltd.
President
Ryoji Musha
musha@musha.co.jp
http://www.musha.co.jp
Tel ＋81-3- 3740 2143
2-16-7-3912, Konan,
Minato-ku, Tokyo
108-0075,Japan

27February 2024

Strategy Bulletin vol350

Figure 1: Japan's earnings yield government bond yields, and the spread between the two
(%)

13
11
9
7
5
3
1
-1

10-year government bond yield(before 1987 electricity company bond)Equity earnings yield

Dividend yield

10 (%)

Equity earnings yield - Government bond yield (yield spread)

5
0
-5
-10

Bond＞Equity
Equity＞Bond
66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22

Source: Bloomberg, Musha Research

Figure 2: U.S. earnings yield, government bond yields, and the spread between the two
20
18
16
14
12
10
8
6
4
2
0

(%)
Earnings Yield
10Y Treasury Yield

Dividend Yield16
14 (%)
12
10
8
6
4
2
0
-2
-4
-6

Earnigs Yield- TreasuryYield (yield spread）

Bond＞equity

Bond＝Equity Equity＞Bond

Bond＞Equity

00 05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 15 20
Source：Robert Shiller、Musha ResearchQ) It is hard to imagine a new era of prosperity for Japan, but what form will it take?
A) Japan will become a high-tech manufacturing powerhouse. The hub of high-tech manufacturing in East
Asia shifted from Japan to China, South Korea, and Taiwan 30 years ago. The image of this returning toJapan is almost certain. The current semiconductor boom can be seen as a harbinger of this. As we havelong explained, the semiconductor boom and the weak yen that have brought about the current improvementin Japan's business climate would not be possible without changes in the geopolitical environment of theCold War between the U.S. and China. The elimination of China from the global supply chain as planned by
the U.S. government and the resurgence of Japanese industry are now underway.

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Q) Even if the U.S. government's scenario is correct, will the private sector, which acts basedon profitability and economic rationality, follow suit?
A) Economic rationality will follow. Government subsidies and the weak yen will facilitate this. Taiwaneseand South Korean high-tech companies are investing heavily in Japan, believing that investment in Japan
will determine the future of their business. Taiwan's TSMC, Korea's Samsung, SK Hynix, and Taiwan'sPowerchip Semiconductor Manufacturing Corp (PSMC) have already announced their investments.
In addition to the generous subsidies from the Japanese government, Japan has a strong presence in the
back-end process (assembly process), which is expected to lead to breakthroughs in semiconductor
technology in the future. TSMC has its only overseas development center in Tsukuba Japan, and Samsung
is building a research center for advanced packaging technology in Yokohama. We can expect a virtuous
cycle of investment as global semiconductor investment begins to concentrate in Japan, and investment
attracts investment.

Q) If production must be moved out of China to safer locations, the choice of Japan becomeseven more important for Korean and Taiwanese companies, doesn't it?
A) We can expect a big swell of investment in Japan, especially from Taiwanese companies. According to asurvey by the Japan External Trade Organization (JETRO), investment in China, which used to account forthe majority of Taiwan's outward direct investment, has plummeted. On the other hand, Taiwanese
investment in Japan is increasing rapidly. Taiwan's direct investment in China declined 39.8% in 2023 fromthe previous year to $3.04 billion (456 billion yen). In contrast, according to Japan's Ministry of Finance,
Taiwan’s direct investment in Japan surged 46.9% from the previous year to 269.7 billion yen.
The reason for the sharp decline in Taiwanese investment in China is that, in addition to the slowdown in the
Chinese economy, the U.S.-China conflict is in full swing, and the U.S. is steadily closing the outer moat toeliminate China. Starting with the Trump administration's tariffs on Chinese products, the export restrictions
on advanced semiconductors against Huawei and other companies have completely changed the businessenvironment for Taiwanese companies in mainland China. Trump, who is said to be the closest to becoming
president-elect, has said that he will raise import tariffs on Chinese goods to 60% across the board. Tradebarriers between the U.S. and China, which are now limited to certain cutting-edge products, will risedramatically and eventually deal a devastating blow. Companies must act before that happens.
China's high-tech manufacturing industry has been nurtured by Taiwanese companies such as Hon Hai,
which has been the sole producer of Apple's smartphones. 2010 saw almost $15 billion in direct investment
in China by Taiwanese companies, accounting for 83.8% of total out bound direct investment of Taiwan. By
2023, however, as the amount of FDI of Taiwan surged to $27 billion, investment in China had plummeted,falling to 11.4% of total investment. As an alternative to this shift away from China, investment is now coming
to Japan.
Figure 3: Taiwan's Outward Direct
Investment and Share of China (JETRO)

Figure4: Taiwan's Investment in China andShare of Investment in China (Nikkei)

Taiwan’s FDI (mill USD)

China Share of Taiwan’s FDI

100milUSD

FDI to China

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Tectonic shifts in Taiwanese companies' investment in Japan have begun to be seen.
Taiwan Semiconductor Manufacturing Corporation (TSMC) has completed the first phase of its Kumamoto
plant (1.29 trillion yen with 467 billion yen in government subsidies) and has decided on the second phase(2.08 trillion yen with 732 billion yen in government subsidies). Founder Maurice Chang announced at the
opening ceremony on February 24 that "the Kumamoto plant will be a renaissance of the semiconductor
industry in Japan. In the past, Maurice Chang expressed his unwillingness to make progress on theconstruction of the Arizona plant in the U.S. "The U.S. is trying to expand semiconductor production in its
own country, but the U.S. already has no manufacturing talent. The cost is 50% higher than that of Taiwanese
products, and it is impossible to go back to the old days (of strong semiconductor production)" (April 2022).
This fact, combined with his high expectations for Japan, is evident.
Other companies include Powerchip Semiconductor Corporation (PSMC) that have decided to invest 800
billion yen in Ohira, Miyagi Prefecture (jointly with SBI), Alchip Technologies Corporation (a designer ofcustom semiconductors for different applications), Global Unichip Corporation (a design company in which
TSMC holds a 35% stake), and, eMemory Technology (which supports the design and development ofmemory semiconductor circuits), and others have decided to enter the Japanese market. Many more
Taiwanese companies are considering starting operations in Japan. Alchip, which had most of its engineersin China as of 2022, has begun to move them out of China, with many of them moving to Japan. The
Japanese government is actively supporting post-5G, AI, and other projects, and "new projects are being
created one after another, expanding business opportunities," a source close to the matter commented,
according to Reuters.
There are expectations of stronger cooperation with Taiwanese high-tech network. The fablesssemiconductor companies with the greatest growth potential today, such as NVIDIA, Broadcom, Qualcomm,and MediaTek, owe their competitiveness to TSMC's superior production capacity. The majority of thesefabless companies are managed by Taiwanese (Figure 6), and the significance of Japan's involvement in
the Taiwanese semiconductor industry pyramid with TSMC at the top can be imagined to be significant.
Sharp, which is now under the umbrella of Hon Hai, is also expected to strengthen its role as a production
base.
(Strategy Bulletin No. 305, May 6, 2022, "TSMC's Strengthening of its Japan Base and Taiwan-Japan
Industrial Cooperation Will Be Key: The Japanese Industry Revival Kamikaze, the Weak Yen, Has Arrived!
See also.
https://www.musha.co.jp/short_comment/detail/305
Figure 5: Global Semiconductor Market Size and Share (2020)

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Figure6: Top Ten Fabless Semiconductor Companies and Taiwanese Connections

Q) Even so, the Japanese government's support for entrepreneurship is very generous. You arepromoting massive industrial support, but how can the Ministry of Finance approve it?
A) The Ministry of Finance is also suddenly more generous when it comes to requests from the U.S. or whenit comes to national security matters. In addition, the Japanese government has huge reserves of unrealized
profits. First, the BOJ's ETF investment returns have exceeded 30 trillion yen. Second, there are hugeforeign exchange gains from its holdings of U.S. Treasury securities. Assuming that the $1.1 trillion inholdings was acquired at 110 yen to the dollar, at 150 yen to the dollar, there would be a huge foreignexchange gain of 44 trillion yen. These can be easily invested as funds for national revival projects.
Figure 7: Outstanding U.S. Government Bond
Investments by Major Countries($ bil.)
1400

Japan

1200

1000

China
800

UK

600

400

200

Belgium
0
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23
Source: US Dept. of Treasury, Bloomberg,
Musha Research

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Q) So, we can see Japan once again becoming the center of the world's advanced high-techindustry. Do you think that the current stock market rally is a sign of such a bright future?
A) A prior example of geopolitics clearly becoming the starting point of economic vitality was the Korean War,which was not merely special procurement but later led to an increase in Japan's position in the international
division of labor. This time is similar. In the first place, the decline of Japan, once the world's leading
semiconductor powerhouse and boasting a concentration of cutting-edge high-tech industries, was also dueto the U.S.' efforts to knock Japan off its perch and its means of doing so, namely, the super-strong yen. The
significance of this reversal may be comparable to the outbreak of the Korean War.
Figure 8: Modern Japanese Stock Price Trend and Geopolitical Development© Copyright 2023 Musha Research Co., Ltd. Although the information contained herein is based on sources that Musha Research believe reliable, Musha Research do not make any representation or
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Furthermore, past performance is not necessarily indicative of future results. Musha Research has no obligations to update, modify or amend this document or to notify a reader in the event that any matterstated herein changes or subsequently becomes inaccurate. When you analyze risks and issues on investment, finance, tax, law and/or accounting conta ined herein, you should take steps to ensure thatyou understand the transaction and have made an independent assessment of the appropriateness of the transaction and it is strongly recommended to seek advice from your own experts and/or advisors,in light of your own objectives and circumstances. This document shall not be construed as and does not form part of an offer, nor an invitation to offer, nor a solicitation or recommendation to enter into anytransaction with DSI or any of its affiliates, nor is it an official or unofficial confirmation of terms. This document and any information contained herein are confidential and may not be reproduced or distributedin whole or in part without our prior written consent.

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