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Japan’s corporates buck the trend

Investors who are keen to determine the progress of Japan’s Abenomics policy are probably focused on the country’s disappointing macroeconomic data. 

But, underneath, could the prospect of earnings growth and cheaper valuations among corporates offer a more attractive investment outlook?

Japan received the biggest downgrade of any country in the International Monetary Fund’s most recent growth projection. Global growth for 2014 was cut to 3.3 per cent from a previous forecast of 4 per cent and Japan’s GDP forecast was cut by 70 basis points to 0.9 per cent.

The GDP downgrade comes as Japanese economic data shows signs of flagging following the consumption tax hike in April. Since then, consumer sentiment, external trade and inflation have all slowed.

Japanese equities have suffered on the back of the sluggish data, with the Nikkei 225 index returning -5.14 per cent for the year to date compared with 1.42 per cent for the broader MSCI World Index.

Nevertheless, investors appear to be moving in the direction of Japanese equities. 

The most recent global fund manager survey from Bank of America Merrill Lynch shows overweight positions to equities slumped by 13 per cent in September based on worries over earnings growth and the outlook for the broader global economy. However, allocations to Japanese equities hit a 10-month peak, with exposure to the region 10 per cent higher than allocations to any other major market.

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In a world where earnings are becoming a growing concern, the potential for profit growth among Japanese corporates is one reason why investors may be drawn to the market despite its poor economic performance.

Schroders Japanese equities manager Nathan Gibbs says: “For most of this year, Japanese equity investors have focused on macroeconomic data, particularly the negative impact from April’s increase in the consumption tax.

“In the background, however, company profits have been growing steadily and there have been consistent upward revisions in profit expectations despite a summer of weak economic data.”

Fidelity Worldwide Investment Japanese equity manager Alex Treves also highlights improving conditions among corporates as an important driver for the Japanese market.

“The Japanese government keeps pushing for reform but what is more important for the stockmarket is the corporate sector increasingly is looking at returns and balance sheet management as well as its own profitability. There is also more emphasis on stewardship and governance,” he says.

But what is driving profits in Japanese stocks? Gibbs says: “We are seeing the benefits of restructuring and cost-cutting, which were undertaken during the country’s period of deflation, resulting in higher operational gearing for companies.”

Even seemingly bad economic data has helped Japanese corporates improve profits. Recent “sluggish” export growth has left many firms unaffected, according to Gibbs. He says: “Companies seem to be reaping the benefits of their previous strategy to locate production assets offshore. This is allowing those that were previously dependent on the exchange rate to benefit, even while export growth remains anaemic.”

However, Whitechurch Securities head of research Ben Willis says the third arrow of structural reform under Abenomics is necessary for ensuring long-term earnings growth.

“While monetary and fiscal stimuli have changed investor expectations of Japanese equities, structural reform is most important for improving and unlocking long-term earnings growth potential,” he says.

Rathbones head of multi-asset investing David Coombs says valuations in Japan could make the market a “good buying opportunity for the long-term investor”.

Japan is currently trading around 40 per cent cheaper than the US market on a price-to-book basis, according to Coombs. He says: “While we are not super-bullish on the region, Japan is trading on a significant forward discount to the US and we believe there is value to be had. 

“Also, if you believe the third-quarter economic figures will be strong, this dip provides a good entry point.”

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Coombs points to the £319m Invesco Perpetual Japan fund as an example of an attractive value play on Japan while the £643.7m JOHCM Japan fund is also an example of a large-cap value portfolio that does not hold major Japanese stocks like many other funds of its type.

Treves agrees the Japanese market looks cheap – provided one is prepared to hunt beyond the areas that are currently grabbing headlines.

Companies providing services for the elderly are currently off the radar, he says, and they also offer a way of tapping into the opportunity available from Japan’s ageing population.

Treves says: “In aggregate, the Japanese stockmarket is as cheap, price to book, on a p/e basis as it has been for a generation and, compared with other markets, it is also looking quite good value.”


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