SMBC Nikko Securities' "Corporate Earnings Outlook for 2025-2026"

SMBC Nikko Securities has published its "Corporate Earnings Outlook for 2025-2026," presenting a comprehensive analysis of the Japanese equity market, centered on the firm's proprietary NIKKO250 index, which covers approximately 75% of the total market capitalization of all listed Japanese companies. The outlook revises its forecast for the fiscal year 2025, downgrading near-term profit expectations, while introducing a new, more optimistic forecast for fiscal year 2026. The analysis is framed by a cautious outlook on the global macroeconomic environment, potential risks from US trade policy, and domestic political uncertainty stemming from the upcoming Upper House election in Japan.

Revised Earnings Forecast for FY2025 and New Outlook for FY2026

The central message of the outlook is the downward revision of its corporate earnings forecast for fiscal year 2025 (ending March 2026). For the NIKKO250 index, the projected recurring profit growth is now 1.6% year-over-year, a significant reduction from the 6.4% growth forecasted in the previous report from March 2025. This revision constitutes a 2.8% cut to the absolute level of expected recurring profit. Similarly, net profit growth for FY2025 has been revised down from 7.3% to 2.9%. In stark contrast, the report introduces its first forecast for fiscal year 2026 (ending March 2027), anticipating a strong rebound. It projects recurring profit growth of 10.1% and net profit growth of 9.6% for FY2026, suggesting that the current headwinds are expected to be temporary. The primary assumptions underpinning these forecasts have also been adjusted; for FY2025, the WTI crude oil price assumption was lowered from $68.0 to $56.0 per barrel, and the USD/JPY exchange rate was adjusted from 150.0 to 145.0, reflecting a stronger yen.

Sector-Specific Performance and Drivers of Revision

The outlook details a clear divergence in performance between manufacturing and non-manufacturing sectors. For FY2025, the manufacturing sector is still expected to drive growth, with a recurring profit increase of 8.3%. However, this itself is a downward revision from the previous forecast of 11.4% growth, representing a 4.6% cut to the profit level. The non-manufacturing sector, meanwhile, is now projected to see a 6.0% decline in recurring profit, a sharp reversal from the previously expected 0.8% decline. This downward revision in the non-manufacturing sector is a primary contributor to the overall downgrade of the NIKKO250 forecast.

The specific drivers of these revisions are detailed at the sector and company level. The most significant negative revision came from the "Oil & Coal Products" sector, which was revised down by 57.4%. This was attributed to lower oil price assumptions and rising costs impacting major players like ENEOS Holdings and Idemitsu Kosan. The "Rubber Products" and "Shipping" sectors also saw substantial downward revisions of 31.8% and 26.7%, respectively. The shipping sector's downgrade was due to reduced profit contributions from container shipping affiliates and a stronger yen assumption impacting major firms like Mitsui O.S.K. Lines and Nippon Yusen. The "Electrical Machinery" sector was revised down 2.8%, a figure heavily influenced by Sony Group's spin-off of its financial business, which is a technical factor removing that business's profits from the forecast. Excluding Sony, the sector's revision would have been a more modest 1.2% downward. Conversely, some sectors saw positive revisions. "Pharmaceuticals" was revised up by 6.7%, driven by increased expectations for drug development pipelines at Takeda Pharmaceutical and Chugai Pharmaceutical. The "Services" sector was revised up 5.4%, largely due to the positive performance of financial services at Japan Post Holdings.

Macroeconomic Cautions and Investment Strategy

A significant portion of the outlook is dedicated to the macroeconomic environment, where the firm advises increased caution over the next several months. The analysis highlights the resurfacing risks from US-China trade tensions and the potential for slowing global growth. The report notes that since the announcement of mutual tariffs, the market has been volatile, reacting to every headline. While market sentiment has improved recently, SMBC Nikko's strategists believe the negative effects on the real economy will gradually become apparent, as evidenced by softening economic data. The Fed's Beige Book has already pointed to slowing economic activity and rising cost pressures from tariffs. Furthermore, US soft data, such as the University of Michigan Consumer Sentiment Index and manufacturing sentiment indicators, show signs of deterioration.

In response to this expected economic slowdown, the report anticipates that the U.S. Federal Reserve will adopt a more accommodative monetary policy, forecasting two interest rate cuts within the year, starting in September. This environment of decelerating growth and falling interest rates informs the report's recommended investment strategy. The analysis suggests that investors should pivot towards "Quality" stocks. Historically, the Quality factor has performed well during periods of declining US Treasury yields. The report further refines this by recommending a focus on companies with high and stable profit margins within the Quality universe. The rationale is that such companies, which often sell high-value-added goods and services, are better positioned to pass on any tariff-related costs and are less susceptible to a decline in demand, making their earnings more resilient. This shift from Value to Quality is already observed to be underway in the Japanese market.

Japanese Domestic Political Risks

The outlook also turns its attention to domestic Japanese politics, identifying the upcoming Upper House election on July 20 as a source of uncertainty. The primary focus is on whether the ruling LDP-Komeito coalition can retain its majority of the 125 contested seats. A loss of the majority could complicate policy-making and force the government to make concessions to opposition parties. The key election battlegrounds are economic policies, specifically "tax cuts" and "measures against high prices." The report notes a divide between the ruling coalition, which is hesitant on a consumption tax cut due to fiscal concerns, and opposition parties, some of whom are campaigning on temporary eliminations of the tax for food items. Both sides are proposing cash handouts, which the report characterizes as potentially fiscally irresponsible measures aimed at winning votes. The report draws a parallel to the UK's "Truss shock" of 2022, warning that if the election results in a fiscally reckless policy mix, Japan could face risks of a weaker currency, rising bond yields, and falling stock prices. Historically, stock market performance in the 10-30 trading days following an Upper House election has been weak, and the report sees little reason for this election to provide a positive catalyst for the market.

Valuation, Shareholder Returns, and ROE Outlook

On valuation, SMBC Nikko concludes that the Japanese market is fairly priced but lacks strong immediate catalysts for a significant upward re-rating. Based on the new forecasts, the NIKKO250 index trades at a forward Price-to-Earnings (PER) ratio of 15.0x for FY2025 and 13.7x for FY2026. This is in line with the historical average since 2015. With the firm's earnings revision index trending in negative territory, the report suggests that a significant upward surprise in corporate earnings is unlikely in the near term, which will likely keep valuations tethered to historical averages.

A key pillar of support for the market, however, is the exceptionally strong commitment to shareholder returns. Corporate share buybacks, which reached a record high in FY2024, are on pace to surpass that record in FY2025 based on data through the end of May. Dividend payouts are also expected to reach a new record high in FY2025. This aggressive return of capital to shareholders, combined with earnings growth, is a primary driver of the positive outlook for Return on Equity (ROE). The report forecasts that ROE for the NIKKO250 will reach 10.0% in FY2025 and rise further to 11.0% in FY2026. Achieving two consecutive years above the psychologically important 10% level is seen as a significant milestone, reflecting fundamental improvements in corporate governance and capital efficiency. The report suggests that while the focus in recent years has been on enhancing shareholder returns, the next phase of corporate Japan's evolution will be judged on its ability to balance these returns with strategic growth investments.

Conclusion

In conclusion, the SMBC Nikko Securities outlook presents a multifaceted view of the Japanese equity market. It signals short-term caution, reflected in its downward revision of the FY2025 earnings forecast, driven by a deteriorating global macroeconomic picture, specific sector challenges, and domestic political uncertainty. However, it maintains a constructive long-term view, with a forecast for a strong earnings rebound in FY2026. The firm’s recommended investment strategy is to navigate the near-term volatility by focusing on high-quality, high-margin companies that are resilient to economic slowdowns. Underpinning the market's fundamental appeal are the ongoing structural improvements in corporate governance, leading to robust shareholder returns and a sustained rise in ROE to levels attractive to global investors. The key challenge for Japanese companies going forward will be to demonstrate that they can successfully reinvest for future growth while maintaining this newfound capital discipline.