Japan has unique factors in its favour

This article is part of
Investing in Asia - February 2014

The economic policies of prime minister Shinzo Abe – ‘Abenomics’ – promised to end two decades of deflation and the stockmarket recovered sharply.

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.

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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.”