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The Guide: Half-year reviewHandsome rewards for patient investors in Japan
There is a pretty straightforward checklist when it comes to making investments, and Japanese equities are currently putting firm ticks in three key boxes. They’re good value, have a supportive backdrop and are under-owned by the broader community. This sets contrarian juices flowing. There are risks as with any investment, but on balance there is not a better candidate to go overweight within developed equity allocations.
Eight years into a bull market is not a time to find table-thumpingly cheap value opportunities, but Japanese stocks stand up very well against their developed peers. At 14 times next year’s earnings, it’s hard to argue against Japanese stocks looking a bit cheap. Set this alongside global stocks trading on 16.5 times and US stocks on 17 times, and the case becomes more compelling still. The value is decent, but it alone won’t make you money.
More classical valuation scores might be drawn to the dividend on offer from Japanese stocks. At a 2.2 per cent yield, it’s not only more than could be received from US stocks, but commensurately more than the near zero per cent on offer from a Japanese 10-year government bond. The right catalysts are in place to realise the strong potential returns implied by such multiples.
Earnings are growing. In fact, this is nothing new in Japan but the rate is now picking up, with earnings growing at almost 20 per cent based on last year’s levels. This is partly a function of better demand, but also a result of the better corporate governance being implemented by companies. Japanese firms are cash rich and are starting to put that to work productively – growing at the same time as returning cash to shareholders in a more conventional, more western way.
Central bank policy provides a further tailwind to stocks, helped by the measures enacted in September last year. The commitment to buy up 10-year government bonds such that their yield doesn’t get much above zero is inflationary and helps change the investment culture in what’s been a deeply conservative Japan. This will help alter the psychology of investors and companies who’ve known three decades of grinding deflation where cash has been king and risk taking penalised.
Companies – helped by the recent Corporate Code – have already started getting cash to work, and this might be the impetus to change the equity ownership culture, which currently sees the average 40-year-old being 100 per cent invested in cash.
In addition to the central bank bond buying, the labour market is also pushing on the inflation lever. Unemployment in the country, currently at 2.8 per cent, is at its lowest level for 20 years, with the jobs/applicants ratio higher than it has been in 40 years. This should be inflationary and there have been early-stage examples of this, with the cost of a postage stamp rising on June 1 for the first time in 23 years.
In today’s uncertain world, Japan’s stable political system stands out with virtually no political or social unrest. Prime minister Shinzo Abe’s popularity is high, as is his parliamentary majority, and a recent approval for a change to legislation allows him to stand for a third leadership term in 2018. Re-election could see Mr Abe lead through to September 2021, which should mean ample time to embed ‘Abenomics’.
The final pillar in the Japan case is the contrarian opportunity it presents. Sentiment has warmed slightly to the market in recent months, but global managers remain significantly underweight the region. This presents an opportunity for flows to reverse and chase into the market. Price is never the best guide to value, but the fact that the Topix index is broadly at the same level as it was in 1990 – while the US Dow Jones index is 700 per cent higher over the same period – highlights the starkness of the underperformance and the contrarian opportunity it presents.
Like any investment, Japan comes with risks. Specific risks centre around tensions in North Korea, Chinese naval excursions, poor demographics, challenged corporate governance and future tax increases. We believe these risks are not only compensated for within valuations, but are worth bearing given the handsome rewards on offer.
Rory McPherson is head of investment strategy at Psigma Investment Management
Japanese stocks are struggling to find favour
Some commentators have been left bemused by a lack of support for Japanese equities this year as flows fail to tally with professed positivity. Multi-asset and global equity managers, and fund buyers, listed Japanese equities as a priority coming into 2017, while surveys found sentiment on Japan to be persistently strong.
But this has yet to be matched by investors putting money to work. The latest fund manager survey from Bank of America Merrill Lynch even found Japanese equity allocations fell sharply to a net 1 per cent overweight, down from a net 12 per cent overweight in May. The decline comes despite earlier readings showing strong demand for the asset class.
As ever with Japan, currency plays a role. The yen has risen nearly 5 per cent against the dollar year to date, hurting equity returns and sentiment. The Topix index is up 7 per cent in the same period, but US, European and UK stocks have gained 13, 10 and 8 per cent, respectively.
