Jonathan Greig, manager of the Hermes Japanese Equities fund, remains untroubled by the recent decline in the Topix, believing there is long-term momentum in Japanese markets
After the strong run for Japanese equities over the past six months, are you concerned about the recent decline?
While the market rose by almost 70% in the 6 months to mid-May, the recent ‘correction’ in the main TOPIX index has been around 15%, or just over 20% of the net gains over that period. The index is still only back to where it was in early April. Some of the exuberance in the market has clearly taken a knock in the past two weeks, but the fundamentals do not appear to have changed in any significant way.
The initial rally was clearly a yen-inspired one, but that was only a key with which to restart the failing engine of the Japanese economy. Japan had been hit over the previous 18 months by a combination of earthquakes, floods, the crisis in Europe – as well as the spat with the Chinese over a group of uninhabited islands in the South China Sea.
Over the same period, the yen climbed against all its major trading peers, adding to the overall lacklustre demand for many Japanese made products. This added to the long-term deflationary pressure on domestic prices and incomes that had developed since the mid-90s.
The new government’s aim of achieving 2% inflation within two years seems dramatic against the recent historical evidence. However, higher import prices as a consequence of the weaker yen and better earnings from some of Japan’s leading employers has had the most immediate impact on asset prices – notably equities. If it can be sustained into 2014, the long-term impact on the wider economy cannot be under-estimated.
Do you need to be acutely aware of the prevailing macro environment when investing in Japan?
Our investment strategy is not based on macro factors such as the yen, but on the sustainability and growth in specific corporate returns. Our bottom-up approach thus makes macro factors a residual of the portfolio weighting. However, it cannot be denied that short-term performance can be influenced by rapid changes in the economic environment, such as we have seen in the past six months.
We therefore do not take an explicit market view, but on balance our contact with Japanese companies over the past few months suggests they are prepared to buy into the new policies and are clearly seeing some easing of the competitive pressures faced in recent years.
We are therefore confident the fundamental earnings basis for valuing Japanese shares still stands up. Unless there is a major decline in end demand for Japanese exports, the follow through from the export-led growth to a more domestic-led one could further lift the market for the remainder of 2013.
Do you think the Abenomics are working?
In the sense the markets have reacted positively and corporate Japan appears to be buying into his aims – if not all the specifics of certain policies – Mr Abe’s policies are working; or at least those focused on easing monetary and fiscal policy.
We are yet to get details of more specific policies on deregulation and the promotion of new areas of long-term growth. But Mr Abe moved quickly in December to establish the Economic and Financial Advisory Council and the Industrial Competition Council, which are under his direct control.
By the middle of this month the government is expected to announce a broad programme of possible reforms – from areas such as health and education, all the way to proposals on tax incentives, deregulation of markets and the promotion of international opportunities.
Should Mr Abe obtain the majority he seeks after the Upper House elections in July, he will then have to steer specific proposals through the bureaucracy, chiefly the METI and MOF.
Pessimists are already arguing that he may not be able to overcome entrenched bureaucratic inertia, but this may be based on historical precedent. Mr Abe has already moved to side-step both METI and MOF via his own network of advisory committees, while he has a strong support network amongst major employers and other advisors. In Japan, as elsewhere, most people seek to be on the winning side. Alongside the BOJ, it cannot be denied that Mr Abe appears to be gathering momentum.
What areas of the market are you finding value in at the moment?
Our value-based approach looks at companies across the entire market and in general there has been more value in domestically-oriented stocks, rather than the exporters.
Part of this reflects the fact Japanese GDP growth has been relatively anaemic over the past 10-15 years, with downward pressure on incomes and expenditure due to the consistent rise in the yen over this period.
Domestically-oriented companies have had to work hard just to sustain any given level of revenue and profit, let alone growth. Some have been far more successful than others, especially the new and more nimble entrants since the late 1990s.
Yet even among some of the more traditional retailers, such as department stores, there have been some turnaround stories, which have provided us with strong performance gains irrespective of the yen.
Japanese equities have been extremely volatile in recent weeks, how have you navigated through this?
Even though we are long-term value investors, we are not immune to sharp swings in the general market. Having a focused portfolio of 25-35 stocks also means that concentration in certain sectors or specific stocks can have an impact on short-term performance.
However, data suggests that over the long term, value-based investing has produced the most consistent level of outperformance in Japan. It is more pronounced in Japan than in other major global stock markets. Therefore, as long as the conviction on the stocks in our portfolio remains unchanged, we tend not to react to short-term market movements.