Part of the reason for this stems form Japan’s location and the strong export markets of Asia and China in particular, where its strong presence in capital and consumer goods has been a powerful source of growth over the last decade. With any revival in global or regional demand, government-inspired spending and inventory restoration, the Japanese economy will benefit significantly.
The country’s industrial success story remains largely misunderstood by many analysts from other regions, who concentrate on the years of declining stockmarket and seemingly intractable economic challenges.
However, Japan remains home to some of the world’s most dynamic industries and continues to experience significant evolution in business practices that make it more attractive than ever for institutional investors.
For example, Japan’s manufacturing sector remains at the forefront of global innovation and Toyota (including its Lexus brand) holds a 80 per cent share of the global hybrid automobile market. The country’s quest for energy efficiency and innovation will continue to drive advances in the textile, metals and transport industries.
Instead of decline, the picture is increasingly of cash-rich corporations well positioned to see through the recession and emerge at the head of growth when the cyclical upswing emerges supported by a banking system that has remained fairly stable during the crisis.
An appreciation of this may be reflected in the market returns this year. The Nikkei has returned 8.94 per cent against 1.59 per cent for the Dow and 1.06 per cent for the FTSE as of July 21, 2009 in local currencies.
So why the scepticism? Many people see Japan as a greying society with little macro-economic growth lagging behind the US for many years.
In reality, though, there has also been a period of uninterrupted, steady growth in Japan. Additionally, much is made of the equity market declines and the “lost decade” but, even before the recent crash, Japanese equity valuations were lower than investors may have realised.
There are low levels of international investor interest. Based on data from Goldman Sachs, US international mutual funds are heavily underweight Japanese equities. This is not new but the degree has widened to historic low proportions. In our opinion, it is unlikely that this underweighting of Japan will continue indefinitely and if a change does occur, valuations may well improve.
With the US seemingly stabilising and most commodity prices rallying, it may not be long before Japanese investors realise that the future is brighter for their own country too, encouraging domestic retail investors again.
It remains somewhat baffling that European investors are persistent in their scepticism about Japanese equities as their unhedged GBP returns have outperformed the US over a number of periods, most notably the last two years. This could be based on a lack of appreciation of how growth in international trade, particularly within Asia, affects Japanese companies rather than focusing simply on prospects for domestic growth.
If, as we expect, economic growth rebounds earlier in Asia and China continues its stimulus, our view is that Japan’s economy and corporate earnings will rebound quite firmly. Indeed, much of Japan’s recent earnings’ disappointments was affected by the mark-to-market valuation of cross share-holdings which will naturally reverse themselves when equity markets recover.
In summary, global investors should ignore Japanese equities at their peril as the country is a key player in Asia which may well exhibit the strongest growth prospects over the next decade but the currency base will matter.
Yu Iwata is investment product director of Nikko Asset Management