Oct 11 2017

Oracle: Japan goes for growth

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
Oracle: Japan goes for growth

Last week, I got the chance to catch up with one of the Japan equity portfolio managers at JP Morgan Asset Management. When it came to his asset class, he took a positive view – as you would expect – but a few things he said particularly stood out. At a time when politics is up in the air, it is good to take a look at the data.

First, Japan’s economy looks to be in good shape, with strong GDP growth, low levels of unemployment and improving business sentiment. Second, corporate governance best practices have taken longer to be adopted by Japanese companies than in other developed markets. This presents upside potential for stocks, which can improve their delivery of positive shareholder returns.

Third, Japanese equity valuations are not expensive compared with historic figures or other markets and exhibit weaker correlations to other major equity markets. This means that investing in the asset class can help diversify portfolios.

Estimates for Japan’s GDP figures for the first half of 2017 were knocked out of the park as growth came in at 4 per cent (the seasonally adjusted annual rate). That is well ahead of the 2.5 per cent predicted.

Inflation levels remain low, but concerns over the economy falling back into deflation seem to be subsiding. Japanese earnings have also been detaching from a reliance on a weak yen, which is supportive of Japan equities.

The Tankan business survey, which asks thousands of Japanese companies about current business conditions as well as their intended activities over the next year, is showing an improvement.

Both manufacturing and non-manufacturing industries are heading upwards, suggesting a broad pick-up in the Japanese business environment. The labour market remains tight, with the unemployment rate continuing a downward trend. The jobs-to-applicant ratio shows that there are more than 150 jobs available for every 100 jobseekers. Despite this tightness in the job market, wage growth remains low. 

The most interesting development the portfolio manager highlighted was the sea change that is currently reshaping Japanese corporate culture. Corporate governance and the focus on increasing returns to shareholders has been improving.

Historically, Japanese companies have held large amounts of cash on their balance sheets when compared to other global companies. Japanese corporates are increasingly using the money they once held as cash to pay dividends and initiate share buybacks to the benefit of equity investors.

The increased use of return-on-assets and return-on-equity targets is another sign of the rising focus on delivering shareholder returns. Japanese companies have notably lagged other major markets in this respect, often focusing more on building market share than on return on investments. However, the proportion of Japanese companies that are now including return-on-investment targets in their medium-term plans is growing.

The quality of company boards has also improved over the past few years. The number of businesses appointing external directors has doubled since 2010 and there has been a shift towards appointing multiple external directors to increase the independent influence on boards.

Japanese equities could deliver positive returns over the medium term, driven by attractive valuations and an improving business environment, which is supported by healthy growth and continuing accommodative monetary policy.

In the past, the performance of Japanese equities has been tied to the strength of the yen against the dollar. In recent times, Japanese earnings have been less dependent on a weak currency and investing in this asset class should no longer be viewed as just a currency play.

In a market where many businesses and industries face structural challenges, there will be a wider divergence in the performance of companies. Active managers have the ability to avoid stocks with less promising outlooks and focus on a combination of “new” industries for which Japan has a sustainable advantage, and corporates that aim to deliver more on shareholder returns.

Nandini Ramakrishnan is global market strategist of JP Morgan Asset Management