Yen weakness, low interest rates and relatively low inflation are setting Japan distinctly apart from its developed market peers, says Mitesh Patel, Japanese equities manager at Jupiter Asset Management.
He stresses that while it proved a tricky start to the year for investors in Japanese equities – especially international investors for whom yen weakness has been a pronounced headwind – in local currency terms, the Japanese market has seen performance closer to, and in some cases, better than developed market peers.
As to how Japan differs from said peer group, Patel explains that currency weakness has been caused in part by the monetary policy of the Bank of Japan (BOJ), which has kept interest rates low at a time when other major central banks have already raised rates and signalled further hikes to come.
“The widening differential in interest rates has undermined the yen in FX markets, but to some extent the actions of the BoJ are understandable – after all, in contrast to much of the rest of the world, inflation in Japan remains muted at 1.2%.”
This compares to 8.5% in the US, 7.4% in the euro area, and 7% in the UK.
Inflation, nevertheless, is on a steady upward trend in Japan, Patel says, exacerbated by higher energy costs, as Japan relies on imports for the majority of its energy needs. But in Japan there are longstanding deflationary factors at play as well.
A weaker yen
“Yen weakness increases the costs for business importing dollar-denominated materials from overseas, but corporate Japan is in a good place to absorb those costs, as corporate profitability is as strong as it has ever been.”
And Patel argues that in many respects, higher inflation would be a boon for the Japanese economy – after all they’ve been trying to stimulate inflation for decades now with little success. But he hopes preferably this wouldn’t be ‘cost-push’ inflation driven by rising material prices nor a function of a weakening yen, but instead demand-led inflation triggered by higher wages.
“Wages in the Japanese labour market have been moribund, despite the country’s demographic picture meaning that the employment market is extremely tight.”
Tomoo Kinoshita, global market strategist at Invesco, agrees that depreciation of the yen is expected to have a positive effect on Japan’s economy, but is concerned that if the yen depreciates too rapidly, the outlook for the future of firms and consumers may become unclear.
Schroders makes a similar assessment with regards to levels of uncertainty right now. It remains neutral as the Japanese market is in some senses distanced from the conflict in Europe but says the effect of imported inflation remains a threat.
Japanese market in 2022
This year Japanese market performance, like other markets, has been led by anything that is positioned to benefit from higher commodity or energy prices – for instance mining, oil, energy – but are these sectors the place to be going forward?
Not according to Patel: “We fundamentally see those sectors as unappealing since we do not see them generating value for shareholders across the cycle.”
“Our preference remains for dividend-paying stocks in less cyclical sectors, as well as quality growth companies where their longer-term opportunities remain undiminished even as they deal with short-term headwinds and a reduction in their share price valuations.”
Favoured funds
Josef Licsauer, investment analyst at Hargreaves Lansdown, picks out two favoured funds. Firstly, he namechecks the Man GLG Japan Core Alpha fund.
“The managers invest in large Japanese companies, that mainly feature on the Topix. They invest in companies they feel can be bought at a lower share price than their true worth and sell them when they feel the company and the share price has recovered. This process currently leads them to invest in more economically sensitive – or cyclical – areas of the market, such as banks and insurance.”
Secondly, he picks out the the FSSA Japan Focus fund. This fund invests in companies that are dominant in their industries, and primarily feature on the Topix.
“The managers look to own faster-growing firms and believe the strength and quality of the companies they own is what drives returns over the long run.”
Licsauer adds: “Over two thirds of the fund is currently invested in technology, industrials and healthcare companies. This can change over time, depending on where the managers find what they believe to be the best opportunities.”
He suggests these funds could dovetail well in a broader investment portfolio, as each one focuses on either growth or value investing.
“This means they could perform differently from one another in different market environments, and when different investment styles fall in and out of favour, though we think both funds have the potential to perform well over the long-term.”
