Japan experienced something of a renaissance over the first half of 2013, emerging as one of the strongest performing equity markets. According to FE Analytics over the 12 months to 17 May 2013 Japanese Smaller Company funds were the best per-forming fund sector, up on average over 50%. Second best over that time frame was the broader Japan sector, up 41.51%. From mid-May the Japanese market suf-fered set backs but this was largely seen as a knock-on impact from worries over the US. So does this mean the time of false dawns in Japan are finally over?
Much of the Japan equity market surge and its popu-larity among investors in the first part of 2013 centred on the country’s weakening currency and the percep-tion its government was making inroads in its reforms. We’ve been here, before over the past 20, years but this time it would seem as if the country is truly making progress.
In mid-May, Simon Somerville, manager of the Jupiter Japan Income fund and the Jupiter Japan Select (Sicav) fund noted the US dollar was buying more yen than it has done in over four-and-a-half-years. This, he explained, led to investor interest in shares in Japan’s major exporting companies on expectation that profits and revenue will climb sharply as overseas demand for their products improves. Somerville believes the mag-nitude of the yen’s decline should accelerate the turn-around in the Japanese economy. However, he also warned that a depreciating currency is no substitute for long-term structural reform.
It is here where Japan is making progress in which investors are starting to believe.
Somerville said the yen’s slump in value is just the most visible result of what has become known as Abe-nomics – a series of stimulus measures introduced by Prime Minister Shinzo Abe to lift the Japanese economy out of recession and a period of def lation that has lasted some 15 years. “When Abe spelled out his economic policy, he famously drew inspira-tion from a well-known Japanese legend – the story of the three arrows – to illustrate the need for coor-dinated action on three fronts: monetary, fiscal and structural.
“By launching an aggressive monetary policy and boosting government spending, Japan’s prime min-ister has fired off two of his three arrows. Champi-oning a 2% inf lation target, Abe’s tough rhetoric on the economy, both during his election campaign and afterwards ignited the recent rally in Japanese stocks. A stimulus package worth 10.3 trillion yen in January has underpinned it, while the Bank of Japan’s massive bond-buying programme, announced in April under the stewardship of Haruhiko Kuroda has prolonged it.
“Add to the mix, a series of tax breaks to boost wage growth and employment and you have all the ingredi-ents which propelled the benchmark Topix Index to its highest level since September 2008.”
In April this year, Barclays’ wealth and investment management team were positive on Kuroda’s promises to double the Bank of Japan’s (BOJ’s) monetary base and more than double the average maturity of the govern-ment bonds it purchases. They said: “Japan suffers from excess saving in the private sector. The def lationary spiral in which the country has been locked since the 1980s has left companies and individuals with little incentive to hold anything other than cash and Japa-nese government bonds.”
Negative rates
By turning the real interest rate negative, while stoking real wealth, the BoJ’s policy could raise investment and lower savings, the Barclays team commented. “The weaker yen is a very desirable side effect of all this. The reaction of the equity market so far would imply that the market is ready to buy into this new strategy. Certainly, reading across third party research on the matter, there seems to be a good deal of interest and readiness to believe in a change of fortunes for the Japa-nese economy.”
In May Japan released its latest GDP figures, which trumped expectations and showed the economy grew at an annual rate of 3.5% over the opening three months of 2013. Nancy Curtin, chief investment officer of Close Brothers Asset Management, noted: “These fig-ures are positive proof that Shinzo Abe’s shock and awe tactics have injected enough confidence to stimulate a stagnating economy and consumer spending. Further growth is likely to follow as the impact from fiscal and monetary policy is fully felt.
“On the ground, large retailers have started to report improved sales as consumers look to buy ahead of higher inf lation following the fiscal stimulus. At the recent G7 meeting no one batted an eyelid at the yen’s devaluation or Japan’s aggressive fiscal policy, and if currency weakening continues it will benefit Japa-nese exporters in the coming months. This could add further impetus to Japanese equities, which are already at five-year highs.”
Somerville also pointed out that the recent equity market rally in Japan is underpinned by increasing evidence Abe’s policies are having their desired effect. “For instance, in March, household spending, rose at its fastest pace in nine years in March and tax-breaks aimed at encouraging companies to raise salaries should help sustain sales.
“That’s certainly the view of companies we met on a recent trip to Japan – whether it was a manufacturer of cosmetics, a retailer or a shopping centre devel-oper, all of them told us they were anticipating benefits from consumption spurred by wage growth. Japanese firms certainly seem to be heeding Abe’s call for higher wages. High profile wage increases have already been announced at retailers FamilyMart and Lawson as well as manufacturers Mitsubishi Heavy, and Toyota. Summer bonuses meanwhile are also reportedly on the rise, up on average more than 5%, which would repre-sent the biggest increase in nearly a decade.”
Bad omens
However, not everyone believes Japan’s H1 2013 market surge bodes well for the future. The investment team at London-based Psigma Investment manage-ment recommended in mid May their fund managers reduce exposure to the region. Tom Becket, the group’s CIO, said: “The main reason behind our (possibly pre-mature) call is that we are now finding it very difficult to assess the fundamentals and valuations of Japanese stocks. When we last rang our cracked bell calling for better days for Japan we knew stocks were cheap. However, since then the market has gone parabolic (up some 70%+ from the lows) and it is much harder to gauge what price we are paying.
“Our view was that Topix earnings would increase by 40% in 2013 and the market would reflect this improve-ment in a comparable gain. Now we feel earnings could rise 70%, again ref lecting the market move from the November lows. But where does that leave Japanese val-uations? Having spoken to Japanese experts, we would ‘guess’ at around 14-15x earnings – neither cheap nor expensive. But this is no longer an ‘asymmetric’ trade and risks have grown as the market has recovered.”
That being said, Becket said he does still expect earn-ings to continue to rise in the years ahead, as the Japa-nese economy continues to heal. Like Somerville, Becket noted the “three arrows” strategy is taking shape and recent economic data and confidence surveys from Japan have been on an improving trend. “As a nation, the Japa-nese seem well up for this fight. The story is not over, but is probably due an interval.” By late May/early June the market experienced just that.
Somerville argues perhaps investors need to look for different opportunities. He said: “With yields on Japa-nese government bonds effectively capped by the Bank of Japan’s massive monetary stimulus scheme, domestic investors will increasingly have to look elsewhere for a decent income stream. We have been buying shares in companies that we think will benefit from this trend.
“Further gains for the Japanese stock market now lie in Abe’s ability to fire the third arrow of structural reform. Specific policies have yet to be announced but the key areas of focus are likely to be increased labour market flexibility, greater female and senior labour par-ticipation, trade liberalisation through membership of the Trans-Pacific Partnership and the creation of ‘national champions’ through the relaxation of compe-tition laws. If these structural reforms are even partially successful, it is not only individual companies that will profit but the entire domestic economy.”
