Japan has unique factors in its favour

However, 2014 has started badly as investors have sought more tangible evidence of recovery, particularly in corporate profits. Could Japan’s nascent revival be over before it has begun?

Last year finally rewarded patient investors in Japan. The average fund in the IMA Japan sector rose 25.8 per cent over the course of 2013, the ninth best performing IMA sector.

Certain sectors of the economy performed even better: The IMA Japanese Smaller Companies sector saw an average return of 34.9 per cent, according to FE Analytics.

But 2014 has been tougher, in both relative and absolute terms. The average fund is down 3.9 per cent for the year to date. Only the Asia ex Japan, China/Greater China and Global Emerging Market sectors have done worse. The more domestic-focused smaller companies sector has fared better with the average fund down just 0.3 per cent, but it has still been a difficult place to invest.

Alex Treves, head of equities for Japan at Fidelity Worldwide Investment, says that the recent correction in Japanese stockmarkets can largely be attributed to emerging market risk and a stronger yen. Equally, after a strong economic performance in 2013, investors are keen to see that the momentum of reform is maintained.

Nevertheless, Japan has a number of factors in its favour over other developed markets. Rob Burdett, co-head of multi-manager at F&C Investments, points out that unlike the majority of other developed markets, the growth in the Japanese market in 2013 did not come from multiple expansion, but from earnings per share growth and higher dividends. This means it has more scope for further growth in 2014.

For example, at January 31 last year the Japanese market traded on 17x earnings and a yield of 2 per cent. At the same point this year, it traded on 15.8x earnings and a yield of 1.7 per cent, in spite of its strong rise during the past 12 months. The S&P 500, in contrast, has moved in the opposite direction. Last year, it was trading on 15.8x earnings and a yield of 2.5 per cent. This year it is on 17.3x earnings and a yield of 2.4 per cent.

Equally, economic figures continue to improve. GDP growth is expected to be 2.6 per cent annualised for the final quarter. The core consumer-price index climbed 1.3 per cent in December over the previous year, suggesting Japan’s economic policies are finally tackling the deflationary demon.

Overall in 2013, prices rose 0.4 per cent, the first annual rise in five years. Employment data is also improving with jobless numbers falling from 4 per cent in November to 3.7 per cent in December.

Mr Treves says: “Japan’s recovery continues to proceed steadily and the reflation theme remains on course. Furthermore, Japan has led the world in terms of positive earnings revisions over the past year and the outlook for earnings growth compares favourably with all other major regions.”

Of course, there are still concerns. The debt burden – at more than 200 per cent of GDP – is still the highest in the developed world. The ambitious target to balance the country’s budget by 2020 is unlikely to be hit, with the most recent government statistics suggesting that the deficit could still be as wide as ¥6.6tn (£39.2bn).

Efforts to rebalance the country’s books are being hurt by the shutdown of nuclear power in the wake of the Fukushima disaster, which has necessitated importing other forms of fuel.

Equally, there is no plan B for the country if Abenomics fails. Japan’s economic situation is unsustainable in the long term, and it is unclear what will happen if the current reforms fail to address the problems.

Mr Burdett is overweight Japan and has been for some time. However, he has hedged the currency for a large part of his exposure. The yen has seen significant falls since the start of Abe’s reforms last year and unhedged investors have lost out.

A key advantage of Japan is that it dances to its own tune. It has shown less correlation with other developed markets historically as it deals with a unique set of economic circumstances. Mr Treves believes that the current rout may provide a buying opportunity.

Certainly, valuations do not look as stretched as elsewhere in developed markets, but Abenomics still has to deliver.

Cherry Reynard is a freelance journalist

ABENOMICS - WHAT IS IT?

Prime minister Shinzo Abe’s reforms consists of ‘three arrows’:

Arrow 1 - Aggressive Monetary Policy

In January 2013, the government and Bank of Japan jointly introduced the idea of a price stability target with the aim of achieving 2 per cent inflation. This was followed in April 2013 with the start of quantitative and qualitative monetary easing (QQME).

Arrow 2 - Flexible fiscal policy

In January 2013, Japan put together an economic stimulus package, with an additional budget of ¥10tn (£59.7bn). In December a further economic stimulus package was announced valued at ¥5.5tn to try and counter the impact of the consumption tax increase in April 2014.

Arrow 3 - Structural reform of the economy.

Deemed the most difficult and important of the three arrows, reforms proposed include reducing the rate of corporate tax, agriculture reform and electricity reform..

JAPAN - WHAT THE EXPERTS THINK

Rob Burdett, co-head of multi-manager at F&C Investments, is a supporter of the Coupland Cardiff Japan Alpha fund, which is a portfolio of mid-cap growth companies, mostly with a domestic bias. He says: “Japan is coming out of two decades of underachievement. Its banking sector is in good shape and can start to lend if there is demand in the economy. This is a structural advantage. Equally, the

government, corporate and banking sectors are all working together. If a wobble leads to lower global growth, Japan has the most predictable growth of all developed economies.”

Gavin Haynes, investment director, Whitechurch Securities, says that while investors have seen the start of reforms coming through, they now want proof of strong, improving profits from Japanese companies. He says: “The significant weakening of the yen that started last year should have a positive impact on the profitability of companies and their global competitiveness. We like funds such as the Jupiter Japan Income fund, which invests in dividend yielding companies. For a hedged fund, we like the Neptune Japanese Opportunities fund, run by Chris Taylor, which should benefit if the yen weakens from here.”