James de Bunsen, Henderson Global Investors multi-manager
We think it is still easier to argue the bull case for Japanese equities than it is for most other major markets at the moment, despite already very strong gains.
Quantitative easing is still key, even though it is largely priced in to financial assets. For investors, Japan is arguably in that win-win situation where bad news on the economic fundamentals side can be translated into good news for markets because it means that the Bank of Japan will be more likely to fire up another couple of printing presses.
There are no signs from either the government or the BoJ that they will stray from their current course until their inflation goals are achieved, even if it means doubling up again.
But the underlying story in Japanese equities is also very encouraging. Positive earnings momentum contrasts sharply with the downgrades we are seeing elsewhere. Valuations look reasonable relative to history and to other developed markets but importantly there are other factors at work that can help boost returns on equity and margins. The term ‘improving corporate governance’ may not set pulses racing but we see tangible proof of a change of attitude in many Japanese company boards and a better outlook for ordinary shareholders. These changes can impact stock prices quicker than you might imagine.
Technicals are not bad either. Admittedly, the increased equity allocations of massive domestic pension schemes are well understood by markets now and it is a consensus trade to be overweight Japan according to positioning surveys. However, data also shows that foreign investors’ buying activity is actually very muted compared to when the market took off in 2012-13. Meanwhile, domestic investors have yet to be enticed out of cash into equities. If this sentiment changes, which seems likely with core inflation at 2 per cent and cash and bond rates at zero, the flows could be very meaningful indeed.
John Husselbee, Liontrust head of multi-asset
The first quarter report card is easy to write. In local currencies, the European and Japanese stockmarkets are outperforming whereas the US was losing momentum and emerging markets in general were still range bound. It would seem that investors are chasing the QE trades and reducing US exposure to do so.
We shifted our portfolios to be overweight Japan in late 2012, believing that Abe would be on target with his three arrows of monetary and fiscal stimulus and reform. Having started my investment career around the peak of the Japanese stockmarket in the 1980s, I have witnessed many a false dawn over a couple of decades of deflationary disappointment. Each time in the past, the initial flame of euphoria has been snuffed out in a political quagmire. Not so thus far, and I believe the weakening of the Yen has been the critical factor here, which had been the global carry trade.
The currency world is a relative value trade, and the Japanese authorities have been successful in weakening the Yen versus the dollar. While initiated in Tokyo, more recently the trade has been more dollar strength than further proactive Japanese response. The stockmarket has reacted in parallel and the best of returns have rewarded those investors who chose to hedge the currency. It remains to be seen whether the stockmarket can move independently of the currency trade.
Looking ahead, we remain positive, with the rate of inflation being the key gauge of the success of Abenomics. Admittedly, the immediate outlook for this measure is not encouraging, which suggests that the authorities will be forced to further ease policy. However, Japanese companies are more competitively situated on the global stage and should increase their market share. A further upgrade will be coupled with an improvement in domestic demand.
Ben Kumar, 7IM investment manager
Investors tend to learn slowly as a group, with hope springing eternal that the previous bursting of a bubble gives a perfect entry point.
However, from 1990 the Japanese stockmarket delivered a 22-year lesson in how to crush optimism, falling more than 70 per cent from its high point.
There were a few false dawns along the way, each lasting just long enough to entice investors over the edge of another cliff. No wonder then that for most international investors the Japanese equity market is treated as something of a lion-taming act – watch the show, appreciate the performers but on no account step into the cage yourself.
Since late 2012 and the arrival of Shinzo Abe as prime minister, the Japanese equity market has been on a sharply rising trend, up over 120 per cent in that period. The investment case still seems pretty compelling: a prime minister determined to see through structural change has been reaffirmed by the population in December 2014, monetary policy remains incredibly supportive, and Japan has a prime location in one of the most economically dynamic regions of the world. Yet international investors remain underweight Japan.
Our view is that this is the first time in 25 years that Japan has had everything going for it. A clear change that can be seen is the number of women entering the workforce – when Mr Abe took power, around 60 per cent of women were employed. That number has now risen to 64 per cent, still well below most other developed nations but an achievement nonetheless.
Separately, the top priority for Abe’s government has been corporate governance – encouraging company management to put shareholder interests first. As Japanese equity owners, that can only be a good thing, and we expect to benefit over the next few years as investors acknowledge this.