SOURCE: Japan Equity Fund

Japan Equity Fund

June 21, 2011 10:44 ET

The Japan Equity Fund Announces Second Quarter Earnings

JERSEY CITY, NJ--(Marketwire - Jun 21, 2011) - The Japan Equity Fund, Inc. (NYSE: JEQ), a closed-end management investment company, today announced its performance results for the three months ended April 30, 2011, the second quarter of its 2011 fiscal year.

For the quarter ended April 30, 2011, the Fund earned net investment income of approximately U.S. $539,000 (equivalent to income of U.S. $0.04 per share) resulting in net investment income for the six-month period of approximately U.S. $307,000 (equivalent to income of U.S. $0.02 per share). In addition, net realized and unrealized losses from investment activities and foreign currency transactions during that same three-month period was approximately U.S. $5,428,000 (equivalent to a loss of U.S. $0.38 per share). As a result, the net realized and unrealized gain decreased to approximately U.S. $3,798,000 (equivalent to a gain of U.S. $0.26 per share) for the six months ended April 30, 2011.

In comparison, for the quarter ended April 30, 2010, the Fund earned net investment income of approximately U.S. $397,000 (equivalent to income of U.S. $0.02 per share) resulting in net investment income for the six-month period of approximately U.S. $185,000 (equivalent to income of U.S. $0.01 per share). In addition, net realized and unrealized gains from investment activities and foreign currency transactions during that same three-month period was approximately U.S. $4,982,000 (equivalent to a gain of U.S. $0.35 per share). As a result, the net realized and unrealized gain increased to approximately U.S. $7,172,000 (equivalent to a gain of U.S. $0.50 per share) for the six months ended April 30, 2010.

On April 30, 2011, the total net assets of the Fund were approximately U.S. $94.3 million. The net asset value ("NAV") per share on that date was U.S. $6.52, based on 14,456,819 shares outstanding. In comparison, total net assets on April 30, 2010 were approximately U.S. $93.8 million, equivalent to a NAV of U.S. $6.49 per share, based on 14,446,336 shares outstanding. Assuming the reinvestment of the U.S. $0.055 per share dividend paid on December 30, 2010, the Fund generated an investment return of 4.43% for the six months ended April 30, 2011, when measured against the NAV per share of U.S. $6.30 on October 31, 2010, based on 14,446,336 shares outstanding at that time. During the same period, the Fund's benchmark, the Tokyo Stock Price Index (the "TOPIX Index"), increased by 3.89% in U.S. dollar ("USD") terms.

As of April 30, 2011, the Fund had 98.28% of its net assets invested in Japanese common stocks. The remaining net assets were represented by a short-term USD-denominated time deposit (0.12%) and other assets less liabilities (1.60%).

As of June 20, 2011, the Fund's NAV per share was U.S. $6.32, based on net assets of U.S. $91.3 million. On the same date, the market price of the Fund's shares on the New York Stock Exchange closed at U.S. $5.86, representing a trading discount to net asset value per share of 7.28%.

Market Review and Outlook

Both the rally in the Tokyo market and the recently benign global economy were interrupted by the earthquake and tsunami disasters on March 11, 2011 as well as the subsequent accident at the Fukushima Daiichi nuclear power plant. However, driven by aggressive foreign purchasing since mid-March, the market then rebounded sharply. After this short-lived rebound, the market entered into a consolidation phase for the remainder of the term, with investors keeping a close eye on both further developments at the Fukushima Daiichi plant as well as the extent of supply chain disruptions among various Japanese corporations.

Summary of Tokyo market-related themes:

(1) Normalization

Supply chain disruptions from the earthquake and tsunami are beginning to wane. Specifically, Renesas Electronics Corporation's microcomputer unit ("MCU") factory, which produces 30% to 40% of the global supply of MCUs used in automobiles, is scheduled to resume production on June 15th. Toyota Motor Corporation, whose production levels are currently below 50%, expects to return to full capacity production by November or December of this year. Expectations for the scale of power shortages in areas supplied by the Tokyo Electric Power Company ("TEPCO") have been revised downward, as the company amended its supply capacity forecast from 45 million kW per hour to 55 million kW per hour, although this figure remains below last summer's peak demand of 60 million kW per hour. The Japanese government is expected to ease its 25% electric power savings requirement for large-scale users to 15%. Separately, after being hindered by the earthquake and tsunami, industrial production was down 15.3% month on month ("MoM") in March and is expected rise by 3.9% MoM in April and by 2.7% MoM in May.

(2) Reconstruction

The National Diet of Japan (legislature) has passed the first of a planned series of reconstruction-based supplementary budgets. The current budget totals 4 trillion yen (approximately $50 billion), and will be used primarily for disaster relief measures, including clearing away debris, building between 60,000 and 70,000 temporary residences, and repairing damaged infrastructure such as roads and ports. With regard to financing, the government has decided to borrow 2.5 trillion yen from the budget that funds the country's national pension reserves. Total funds allocated to the reconstruction effort are forecast to reach as much as 10 trillion yen ($124 billion). In addition to the cancellation of child subsidies and free highway tolls that was implemented by the Democratic Party of Japan ("DPJ") government, it is inevitable that reconstruction bonds will be issued once the government prepares the second round of reconstruction supplementary budgets. Perhaps in response to the encouragement of the Ministry of Finance, tax hikes have also been discussed as another possible method of financing the reconstruction effort. However, an immediate tax hike would be destructive to Japan's fragile economic condition, brought about by the threefold blow dealt by the earthquake, tsunami and nuclear plant accident. At this point, the most likely scenario includes the passage of a consumption tax hike, with the funds used to redeem reconstruction bonds several years into the future. Grand designs for reconstruction are now being discussed by a government-sponsored committee of academics, local governors, writers, an architect and a businessman. The various ideas being proposed include moving communities from the seaside to the hills, creating special economic zones to reduce taxes, launching renewable energy development projects and improving productivity in the agriculture and fishery industries. One thing that is clear, however, is that a simple return to the country's pre-disaster conditions will be rejected.

(3) Economy and corporate profit outlook

The Japanese economy is likely to bottom out in the second quarter of 2011. We forecast annualized gross domestic product ("GDP") growth of -3.7% in that quarter, followed by +2.9% growth in the third quarter and +5.6% growth in the fourth quarter, as reconstruction expenditures should provide a boost to GDP largely in and after the final quarter of 2011. Corporate profits began to show negative growth in the first quarter of 2011, with the aggregate net income of the 544 companies that had announced their business results by the end of April down 33% year on year ("YoY") in that period, the first YoY decline in six quarters. Given the damage from the triple disaster and the lack of profit guidance by many companies, there is considerable uncertainty as to the profit outlook for the six months ending September 2011. However, we believe that a low point is likely to be reached during the current quarter, followed thereafter by sequential profit growth for the rest of the fiscal year ending March 2012. The consensus forecast for recurring profit growth calls for a decline of between 5% and 10% for the fiscal year ending March 2012.

(4) Attractive valuations

The price-earnings ("P/E") ratio of the Japanese market currently stands at 15.5 times estimated earnings, while the price-to-book ratio is at 1.1 times. The average dividend yield is 2.1%, versus a 10-year Japanese Government Bond ("JGB") yield of only 1.2%. Even after taking into account the expected profit declines in 2011, valuations remain attractive.

Since the Tokyo market, as measured by the TOPIX, has rebounded by a better-than-expected 19% since hitting a low on March 15th, a period of consolidation will now be required in order for the market to assess the true impact of the disasters on the short-term corporate profit outlook. However, the traditional stock market adage advising to 'sell in May and stay away' will not necessarily apply to the Japanese market under current circumstances, as the recovery stage for corporate profits should be well underway by at least the second half of the fiscal year ending March 2012, and there will be no change in the Bank of Japan's ultra-easy monetary policies anytime soon.

With regard to sector strategy, we will maintain our overweight positions in Industrials, IT and Materials, while we remain underweight in Consumer Discretionaries, Consumer Staples, Health Care and Utilities. We will maintain a neutral weighting in the Energy sector, as well as in the Financial and Telecom sectors. With regard to stock selection, we will continue to focus on companies with global growth potential backed by competitive edges, and companies that will participate in Japan's various reconstruction projects, including renewable energy developments.

The ten largest industry classifications of the Fund's Japanese
equity investments held as of April 30, 2011 were:

                                                 Percentage of
Industry                                          Net Assets
 1. Electric Appliances                                  14.43%
 2. Transportation Equipment                             12.15
 3. Banks                                                 9.51
 4. Wholesale Trade                                       6.60
 5. Machinery                                             6.43
 6. Chemicals                                             5.97
 7. Communication                                         4.15
 8. Insurance                                             3.90
 9. Pharmaceutical                                        3.86
10. Retail Trade                                          3.78

The Fund's ten largest individual common stock holdings at
the same date were:

                                                 Percentage of
Issue                                             Net Assets
 1. Mitsubishi UFJ Financial Group, Inc.                  4.77%
 2. Toyota Motor Corp.                                    3.85
 3. Honda Motor Co., Ltd.                                 3.15
 4. Mitsubishi Corp.                                      2.82
 5. Tokio Marine Holdings, Inc.                           2.65
 6. NTT Corp.                                             2.25
 7. Mitsubishi Electric Corp.                             2.08
 8. NTT DoCoMo, Inc.                                      1.90
 9. Mitsui & Co., Ltd.                                    1.90
10. JX Holdings, Inc.                                     1.86


                                 Net Realized and
                                 Unrealized Gains
                                   (Losses) on       Net Increase
                                 Investments and   (Decrease) in Net
               Net Investment        Currency      Assets Resulting
               Income (Loss)       Transactions    From Operations
             -----------------  -----------------  -----------------
QUARTER        Total      Per     Total     Per     Total     Per
 ENDED         (000)     Share    (000)    Share    (000)    Share
             --------  -------  -------- --------  -------- --------
January 31,
 2011        $   (232) ($ 0.02) $  9,226 $   0.64  $  8,994 $   0.62
April 30,
 2011             539     0.04    (5,428)   (0.38)   (4,889)   (0.34)
             --------  -------  -------- --------  -------- --------

For the Six
 Months Ended
 April 30,
 2011        $    307  $  0.02  $  3,798 $   0.26  $  4,105 $   0.28
             ========  =======  ======== ========  ======== ========

January 31,
April 30,
 2010        $   (212) $ (0.01) $ 2,190 $   0.15   $  1,978 $   0.14
July 31,
 2010             397     0.02    4,982     0.35      5,379     0.37
October 31,
 2010            (184)   (0.01)  (6,805)   (0.47)    (6,989)   (0.48)

                  435     0.03    3,707     0.26      4,142     0.29
             --------  -------  -------- --------  -------- --------
For the Year
 October 31,
             $    436  $  0.03  $  4,074 $   0.29  $  4,510 $   0.32
             ========  =======  ======== ========  ======== ========


                           Net Asset           Market        Share
QUARTER ENDED                Value             Price*        Volume*
                        ----------------- ----------------- --------
                          High      Low     High      Low     (000)
                        -------- -------- -------- -------- --------

January 31, 2011           $7.06  $  6.23 $   6.35 $   5.40    1,710
April 30, 2011              7.26     5.79     6.66     5.35    1,899

January 31, 2010           $6.54  $  5.73 $   5.69 $   4.74    1,548
April 30, 2010              6.64     5.96     6.02     5.11    1,374
July 31, 2010               6.49     5.76     5.93     4.82    1,067
October 31, 2010            6.47     5.82     5.64     5.10    1,396

*As reported on the New York Stock Exchange.

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