You always tend to hear the same lines from the eternal pessimists on the Japanese economy. Things like “Japan is cheap, but it’s been cheap for a long time, so what’s the difference now?” or “Japan is too slow to change” are often used when describing a region that has been plagued with economic stagflation for three decades.
There is some truth in what those pessimists are saying. Since the bubble burst in Japan, the country has struggled with deflation, zero interest rates, weak banks, adverse demographics, and periodic bouts of negative growth. History has taught us that any talk of an end to that depression has always had to be taken with a pinch of salt.
Last year was horrible for investors on a global scale – but looking at pure numbers you’d think Japan was insulated from many of those issues affecting the rest of world. As a recent outlook from Lazard points out, the Topix was down only 2.5% (yen) compared to the S&P 500 Index which fell close to 18% (US dollar).
“However, the Japanese yen depreciated nearly 24% at one point during the year compared to at the end of 2021 and, as a result, Japan’s equity market suffered like most other major markets relatively speaking, down more than 15% in US dollar terms,” the report adds.
However, events towards the end of the year did indicate some hope for the region – with investors searching for value and security as the global economy’s focus shifted from the threat of inflation to that of recession.
The first is the re-opening of the economy late last year. As I mentioned, Japan has never been the fastest to do anything, but it has reopened its doors to tourists after two-and-a-half years of tough Covid-19 restrictions, with officials hoping an influx of travellers – enticed by a weak yen – will boost the economy. The hope is that while some areas, like manufacturing, have benefitted from a global economic recovery and the weak yen – this reopening will boost service and consumer related areas of the economy.
We’ve also seen the Bank of Japan signal that it would reverse two decades of policy precedent and begin to move away from loose monetary policy, intended to keep wages and prices high. Not only does this open up the potential for future rate hikes, but the move immediately resulted in the yen soaring to a four-month high against the US dollar – although it is still good value in my view.
M&G’s Japan fund manager Carl Vine says the move may have signalled that Japan has exited its affair with structural-deflation. Adding that the Bank of Japan is gradually becoming more comfortable with this same idea. Vine says the BOJ is likely to remain keen to avoid dislocation in bond and currency markets and wants to move incrementally.
This ultra-easy monetary policy has set Japan apart from its peers, particularly in the developed world – giving it more freedom going forwards.
T Rowe Price Japanese Equity fund manager Archibald Ciganer says another reason to be optimistic is the robust and improving corporate sector – something which he says has been overlooked due to the focus on the pandemic, divergent policy, and the precipitous fall in the yen.
He says: “Despite the current uncertainty in the global economy, Japan’s corporates continue to buy back stock and return capital to shareholders at record levels. This is a very encouraging indication of the health of Japan’s corporate sector and the ongoing improvement in corporate governance at the company level in Japan. We believe the relentless pressure by management teams to be more shareholder focused creates considerable opportunity for long‑term investors.”
The final two points I’d like to make are that Japan remains one of the most politically stable countries in the world. Prime minister Fumio Kishida, and the Liberal Democratic Party (LDP) now has overwhelming support to push through much of their reform agenda and other policy proposals without concern for more than three years until the next election. Then there is valuations, with the Japanese equity market continuing to price an economic slowdown. Whether it is the cyclically adjusted price-to-earnings ratio (Cape), forward and trailing P/Es or dividend yield – Japan looks cheap relative to its 15-year median valuations.
There is no doubt we tend to highlight the negatives and overlook the positives when it comes to Japan. Yes change is slow – but it is starting to prove meaningful. It may be time to stop judging Japan by the events of the past 30 years and look towards a number of strong tailwinds promoting long-term growth.
Contenders to consider
Here are four funds I would consider:
Comgest Growth Japan – high conviction
This fund is run by the five-strong team of Chantana Ward, Richard Kaye, Makoto Egami, Junzaburo Hyuga and Heyang Ping and is a concentrated portfolio of only 30-40 high quality long-term growth companies. The team believes that markets fail to correctly price a company’s sustainable competitive advantage, which should help it generate above average earnings growth. To find these companies, the managers look for six factors to determine quality. These are the business model, financial criteria, organic growth, barriers to entry, sustainability of the business and quality of management.
Pictet Japanese Equity Selection – core exposure
Favouring a more large-cap, growth-tilted style, this fund offers investors excellent core exposure to the potential recovery story in the region. Experienced manager Sam Perry uses a combination of market and fundamental company analysis to select Japanese companies that promote good environmental and governance practices and offer favourable growth prospects at a reasonable price. He uses a four-step process that implements both quantitative and qualitative methodologies to aid his research.
M&G Japan – value tilt
This is a multi-cap fund where manager Carl Vine looks to understand how a company works; how it generates profit; whether those returns are sustainable; what is the potential upside and downside; and what its value proposition is. This enables the team to understand the context of the company within its industry sector to get a full picture of its business outlook. The team’s differentiated stock-picking approach aims to identify a large, exploitable gap between the price the market ascribes to a stock and its own estimated value of that stock, based on proprietary research. The fund has a slight value bias, with the final portfolio consisting of around 50 stocks.
Baillie Gifford Japanese Income Growth – growing income
Launched in July 2016, this fund aims to benefit from the improving corporate governance in Japan, as more and more businesses move towards a progressive dividend-paying policy. Managed by Matthew Brett and Karen See, this fund is reasonably concentrated at 45-65 holdings, and will have a natural mid-cap bias. As the team has a total return mindset, rather than a pure income-seeking mandate, it does differentiate this fund and the stocks it will buy.
