Investors retreat from Japan stocks on trade, tax concerns

* Japan exposed to fallout from U.S.-China trade war

* Japanese investors also hunting for overseas stocks

* Portfolio flows to limit gains in resurgent yen

TOKYO, June 25 (Reuters) - Investors are pulling money out of Japan’s underperforming stock market, worried that constraints on further economic stimulus make the country more vulnerable than others directly in the firing line of the Sino-U.S. trade war.

The heavy portfolio outflows from foreign and domestic investors in the six weeks since U.S.-China trade talks broke down could curtail a rising yen, which has been pushed higher by a flight to safety due to heightening worries over trade, global growth and tensions in the Middle East.

Japan’s stock market is Asia’s second-worst performer after South Korea’s, suffering the impact of slower global trade and sluggish domestic demand.

Investors say even China, whose stock markets are Asia’s best performing this year, offers better opportunities as there are companies there not directly affected by U.S. tariffs or those that will benefit from government efforts to support the economy.

Companies across Japan, from factory automation equipment makers and robot manufacturers to shippers, are reliant on China, said Norihiro Fujito, Tokyo-based chief investment strategist at Mitsubishi UFJ Morgan Stanley Securities, while explaining the weakness in markets and flagging business confidence.

“When the potential growth rate is weak and domestic economy is weak, it would be the timing to launch a big economic stimulus package,” he said. “Instead, the government is going to raise consumption taxes. How can stocks rise in this environment?”

A government proposal to raise the nationwide sales tax to 10% from 8% in October has also raised concerns it will dent consumer spending.

Foreign investors have so far this year sold $14 billion worth of shares in Japan, the world’s third-largest economy. More than half of this was sold in the last six weeks, with non-resident investors selling $7.6 billion of Japanese shares for six consecutive weeks starting from May 7.

The backdrop for that was the breakdown in trade negotiations after U.S. officials accused China of backing away from previously agreed commitments. The more than year-long dispute has seen the two sides slap tit-for-tat tariffs on each other’s imports that have damaged global growth prospects.

The fallout has prompted massive fiscal and monetary policy easing in China while other major central banks, including the Federal Reserve, have signalled they may cut interest rates soon.

China and the United States said last week they were reviving talks ahead of a meeting at the Group of 20 summit this weekend between U.S. President Donald Trump and Chinese President Xi Jinping.

China’s stock market is up 26% this year as investors bet on companies that sell to its growing middle class. In contrast, Japan’s Nikkei share average is up only 6% while the Dow Jones index is up 15%.

“It is quite possible that investors want to sell Japan’s China-related stocks but still hold some Chinese stocks related to domestic consumer spending, because China’s government is stimulating domestic demand,” said Kiyoshi Ishigane, chief fund manager at Mitsubishi UFJ Kokusai Asset Management, a passive investor.


Japanese investors have also been exiting domestic markets and have bought a net $9.1 billion in overseas stocks since the week ended May 11.

“Investors are chasing for alpha, and China is where the party is at and Japan is not,” said Takeo Kamai, head of execution services at CLSA Securities in Tokyo. Alpha refers to excess returns fund managers seek to generate over a benchmark index.

Overseas investors say they are not completely negative on Japan, but other countries offer better returns.

“Investors largely want quality businesses with strong growth,” said Kabir Goyal, senior portfolio manager at Brown Capital Management in Baltimore, an active bottom-up investor that focuses on analysing individual companies. Such companies were a minority in Japan, he said.

The Bank of Japan’s limitation in further easing policy, when front-end bond yields are already negative, is also a factor affecting investment flows.

The yen has risen 5% against the dollar in the past two months to around 107, a five-month high, underpinned by expectations the Fed will cut rates, and analysts say it still remains supported by safe-haven flows. Yet, portfolio flows out of Japan are likely to cap the yen around 106 to 105, said Mitsubishi’s Ishigane.

Editing by Vidya Ranganathan and Jacqueline Wong