Investment insight: Japan

  • Gain an understanding of the current economic factors facing Japan
  • Grasp the relationship between market performance and currency movements
  • Understand the challenges ahead
Investment insight: Japan

Japan’s much-publicised reform programme has stalled over the past 12 months. Craig Rickman explores the challenges facing the country’s economy.

At the start of the year, many predicted that the coming 12 months would present a number of challenges to global economies and stock markets. Few predicted just how quickly those challenges would materialise. Stock markets plummeted in January 2016 and this continued into the first weeks of February, leaving investors slightly shocked and very apprehensive about changes to come.

Such a development should not necessarily have come as a surprise seeing as the previous five years had been incredibly positive for the majority of global markets, and there were ample signs that the world had yet to fully recover from the 2008 financial crisis.

One equity market that is no stranger to this kind of volatility is Japan. 

The Nikkei 225 is very much one of the world’s most developed and largest stock markets. However, since its inception in 1950, the index has experienced significant fluctuations, which is best highlighted by the fact that its highest point was reached in December 1989 at over 38,000 points – more than double its current level of 17,000.

Tokyo drift?

Nonetheless, the country continues to attract interest from asset allocators and global fund managers. Alex Crooke, manager of the Banker’s Investment Trust, is one respected manager who was increasing his Japan weighting earlier this year. 

While it is clearly too soon to judge whether this was the correct call, the short term is undoubtedly posing some challenges to those who believe in prime minister Shinzo Abe’s attempts to revitalise the country’s economy – or Abenomics, as the programme of reforms is otherwise known.

Investors in Japanese equities have witnessed high levels of volatility over the past 12 months. After rising above the 20,000 mark as of 1 December 2015, the Nikkei commenced a period of relatively sustained losses. By 12 February, it had dropped 25 per cent to around 15,000, and although the benchmark has since rebounded, it remains down 7 per cent over the past 12 months.

However, UK investors can be forgiven for failing to notice this fall. In fact, were they to have bought a Nikkei 225 tracker 12 months ago, they would now be sitting on a hefty 35 per cent gain. That’s because Japan’s underlying equity market weakness has been driven by a strengthening yen. For investors in the UK, this currency boost has more than offset the fall in the Nikkei.

The development is an unusual one, because Japan’s policymakers have been trying to weaken the yen in order to boost exports. Unfortunately for them, the yen is still seen as a safe haven investment. 

So when investors become nervous over prospects for risk assets, as they did earlier this year, the currency tends to strengthen.

Combine that with the weakness in the pound since the EU referendum, and it becomes clearer why the yen has risen 40 per cent against the pound this year. For equity investors, this means their Japanese assets are now much more valuable.