Japan’s stock market has dropped by almost 13 per cent from its peak and prices fell again this week due to reported investor disappointment that the government did not mention eagerly awaited structural reforms. But this should not turn investors off Japan, UBS Wealth Management argues.

Prime Minister Shinzo Abe failed to mention supply-side measures in his speech that was considered a preview to the "third arrow" of his stimulus policy. As a result, the  Nikkei 225 index fell, and is now down from its peak on 22 May.

So far since last autumn, the dramatic policy moves by Abe on monetary and fiscal policy have boosted stocks and sent the yen down against the dollar and other currencies. For the first time in years, wealth managers and others in financial markets have been positive on Japan, raising allocations to the country's stock market.

The third policy move – or “arrow” – has been the promise of supply-side reforms to overhaul Japan’s rigid economy. Abe’s speech spooked investors hoping for some specific details.

Should investors fret? The answer is no, says Toru Ibayashi, head chief investment officer for wealth management in Japan, and Daiju Aoki, economist.

“While the recent sell-off in the Japanese equity market can understandably spook investors, we believe it was basically profit-taking behaviour following the market's strong rally since October last year, and that Japanese companies' strong earnings-growth outlook will limit further downside potential,” they said in a note.

UBS sees three reasons to stay positive on Japanese equities: solid corporate earnings, reasonable valuations, and positive economic policies by the Bank of Japan and the Japanese government.

“The Abe administration is expected to announce its `growth-enhancement strategy’ in mid-June. We expect the package to include some positive measures such as the creation of special business districts and promotion of alternative energy,” they said.

Entry point

“We believe this sell-off provides a good entry point to Japanese equities, particularly the Japanese exporters which are supported by solid earnings growth and whose earnings-recovery potential is not fully priced in. The next positive catalyst will be the earnings announcements for the quarter ending June,” they continue.

They also argue that stimulatory measures are already starting to boost the real economy. Data for April and May suggest GDP in the second quarter will rise as forecast by 0.5 per cent over the first quarter – still solid after the last quarter-on-quarter report of 0.9 per cent, they said. Inflation in May exceeded the consensus forecast, suggesting that core consumer prices this year could also beat expectations.