- Japanese markets are currently showing strength, but have been vulnerable to shifts in global investor sentiment
- The Japanese economy is showing strength, and corporate earnings are improving, which has not been reflected in valuations
- Picking strong, well-managed companies is key to dealing with Japan’s unpredictability
It is fair to say that the Japanese market can delight and frustrate in equal measure. It is an outward-facing country, and as such, is prone to feeling every speed bump in the global economy. It has suffered as Trump’s accession threatened the march of globalisation, and improved as it has become clear that globalisation will not be derailed. How can investors manage this unpredictability?
Japanese stock markets have rallied strongly in recent months. Partly they have been beneficiaries of the unwinding of some of the fears around Donald Trump. Unarguably, Japan remains an export-driven economy and might have been a notable victim of the US leadership’s desire to ‘make America great’ again. Japanese companies have globalised models and if the world moves against globalisation, they cannot escape the fall-out. As Trump has struggled to push through legislation, Asian markets in general have breathed a sigh of relief.
But there is more at work. Unusually, Japan has been one the brighter spots in the global economy of late. While its annualised GDP growth of 1.2% is a little behind the Eurozone, it remains ahead of the US. A buoyant labour market is helping to boost household spending power, while policymakers are still firmly targeting ‘growth at any cost’.
This strategy has seen policymakers use negative interest rates and quantitative easing to stimulate growth. This is important in its scale, but Japan has had accommodative monetary policy for some time, often with apparently little effect. However, last August saw the government launch a ¥4.6tn ($45bn) fiscal stimulus to boost the economy. In this, they remain the only major economy to use tax and spending policy to drive the economy forward.
Also, policymakers remain united in their intentions and committed to pushing through economic reforms. Prime Minister Shinzo Abe may have lost some of the excitement that accompanied his early economy policies, but he now has greater credibility. Policy errors, such as the disastrous sales tax hike appear to be things of the past.
It is also worth noting that the region also lacks some of the entrenched problems that lurk in the background for other countries – the banking system is robust, for example. It has capital and is willing to lend. This is a supportive economic backdrop. Consumer Price Index inflation is now positive. This may not be exciting in any other country, and remains some way off the Government target of 2%, but this is Japan and expectations are low.
These low expectations also translate into the corporate sector. Japan has some globally successful businesses, well-versed in hardship, which have proven themselves eminently adaptable to different economic conditions. The strongest companies in the region continue to improve corporate governance, and to take advantage of the weaker yen. Japanese companies have experienced a boom in profitability, with earnings accelerating.
Yet this has not been reflected in valuations as it has in, say, the US. Japanese stocks have been steadily de-rated since Japan’s glory years in the early 1990s, albeit from vastly inflated levels. Valuations now look lower than many global peers and a lot lower than inflated US valuations.
Nevertheless, this mounting strength in the economy and in corporate earnings should not mask the need for selectivity. Visibility for the economy is poor, there is always vulnerability in the currency and any spike could dent economic growth and corporate earnings. Lengthy experience of investing in Japan has taught us to be careful.
We believe well-run businesses with good franchises, plus management that supports the needs of minority shareholders will be in the best position to face down challenges, and may provide greater consistency in a market that can be volatile. As such, we look for companies with net cash, strong balance sheets, who are delivering a higher return on the money they invest.
In particular, we are focusing our portfolio on companies that help other companies become more efficient. We believe this will be prized whatever the economic weather, particularly in those parts of the world that are seeing wage costs increase. Automation is a way for companies to cut costs. With this in mind, our portfolio includes a number of robotics companies, which is an area where Japan has particular strength.
Alongside these ‘new economy’ companies, we also hold a number of more ‘old economy’ companies, such as tobacco or railways. The global economy is finely balanced and Japan is a naturally cyclical economy. While this cyclicality is proving beneficial at the moment, we strive to keep balance in the portfolio, blending a range of different sectors to ensure the portfolio can also protect returns in more difficult times.
Returns in Japan tend to come in fits and starts. While we are currently going through a good period, there will be difficult times again. The key is to look for companies that have proved robust in all conditions.
RISK WARNING
The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested.
Please remember that past performance is not a guide to future results.
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