There has been recent improvement in the Japanese economy, which recorded a sixth consecutive quarter of growth in the second quarter of 2017. Archibald Ciganer, portfolio manager of the T Rowe Price Japanese Equity fund, says this improvement ‘has again raised hopes that together with an improving global economy and Bank of Japan stimulus, this could be the catalyst for the long-awaited Japanese growth and inflation cycle’.
He adds: ‘Indeed, corporate profits recently reached two significant milestones: exceeding all-time highs established in 2007, and overtaking the US in delivering the best earnings over the past decade.’
‘Prime minister Shinzo Abe’s premiership has ushered in a renaissance in Japan’s stock market,’ observes Sarah Whitley, outgoing manager of the Baillie Gifford Japanese trust. She says corporate governance reforms are removing some strangleholds on economic growth, while dividend payouts and share buybacks are on the rise. ‘Japanese companies have learned to live with the deflationary brakes of technological advances and an ageing population,’ she adds.
Paul Chesson, head of Japanese equities at Invesco Perpetual, shares Whitley’s optimism. He says: ‘There are several reasons to be optimistic over the near-term outlook for Japan’s economy and equity market.’ Inflation is positive and has been rising, as have wages, and while wage growth has been modest so far, it should be supported by a very low unemployment rate.
The number of companies defying the sceptics by transforming business practices and governance standards is growing, according to Ciganer: ‘This should help deliver profit growth and generate shareholder returns.’ He adds that the volume of shareholder buybacks is increasing, while merger and acquisition activity is slowly picking up. ‘Where implemented effectively, we expect transformational actions to be rewarded through higher valuations,’ he says.
While profit growth has been impressive at face value, Ciganer says observers have been quick to point out that the surge in profits has been driven predominantly by an increase in margins, rather than an increase in top-line sales. But he argues that margin improvement also highlights a significant transformation in Japan’s corporate sector. ‘We believe the valuation case for Japan still holds, and that Japanese corporate earnings growth is likely to exceed that of its global peers,’ he adds.
As well as market-specific drivers, the condition of the global economy will exert a powerful influence on the Japanese equity market. On this point, Ciganer’s view is that we remain in an environment of moderate, gradually improving global growth, which should help the best of corporate Japan perform reasonably well.
Chesson says: ‘The Chinese economy has delivered a period of stability, the US economy remains robust and a more stable yen should boost Japanese exporters.’ Looking beyond 2018, however, he finds the outlook less clear. The potential introduction of protectionist trade policies in the US could be a risk for global trade, while the gradual reversal of central bank stimulus represents another uncertainty. He says: ‘It remains important to closely monitor the external environment, given Japan’s sensitivity to global economic trends.’
Whitley also acknowledges some regional political problems (North Korea and disputes in the South China Sea), but she remains positive about the prospects for the Japanese companies she has invested in. She emphasises that she sees ‘a strong entrepreneurial spirit among management, which many commentators underestimate’. To her eye, there is ‘a genuine commitment to the social fabric of the country through profitable progress and investment which, allied to new technologies, may blossom in what may be a new age of relative prosperity.’
How to buy Japan
TR 1 year 26.3%, 3 yrs 84.6%, yield 0.8%
In October Japan’s stock market surged to a 20-year high, following the successful re-election of Shinzo Abe, the country’s prime minister. There are various ways to gain exposure to the county, but the preferred choice among our fund panel is Baillie Gifford Japanese. Co-manager and Japan veteran Sarah Whitley is retiring in April, but she passes over the baton to a safe pair of hands in Matthew Brett.
Baillie Gifford Shin Nippon (BGS) (adventurous growth)
SPTR 1 year 50.1%, 3 years 181.8%, premium 13.2%, yield 0%
BGS has achieved exceptionally strong returns over the last five and 10 years. Pravin Kumar took over as lead manager in December 2015, and has continued the policy of seeking out the best of Japan’s innovative smaller companies and keeping turnover low. The trust’s closed-ended structure allows it to gear, and makes it easier to back genuinely small companies. Charles Murphy says: ‘It is an exemplar of the value added that the closed-ended structure can bring.’
Fidelity Japanese Values (FJV) (adventurous growth)
SPTR 1 year 47.7%, 3 years 109.5%, discount -6.3%, yield 0%
Fidelity Japanese Values has a reasonable three-year record, but hopes have been high that Nicholas Price’s September 2015 appointment as manager will enhance returns. Price focuses on medium to smaller companies, looking for growth at a reasonable price. His top 10 holdings account for over half the portfolio, and gearing is well above average. Tim Cockerill says: ‘Gearing can bring additional risk, but it can also reflect the manager’s confidence in his trust.’
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