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Is there really more to Japan’s rally than the weak yen?

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09/12/2013
Japanese equity markets have soared in 2013, outpacing gains seen across other stock exchanges after a huge QE programme introduced by Prime Minister Shinzo Abe, but can the market keep climbing?

Abe’s ‘Three Arrows’ policy has helped fuel large gains for both the Nikkei 225 and the TOPIX year to date, with investors flocking to the country’s exporters to take advantage of a huge drop in the value of the yen.

While never acknowledged as a goal of quantitative easing, Abe’s combination of bold monetary policy, flexible fiscal spending and plans to stimulate private sector investment have all helped to push down the value of the country’s currency.

In the past year, it has moved from ¥82 per US dollar to ¥103 currently.
This depreciation has undoubtedly helped boost the country’s equity markets, but are there further gains to follow?

Relative game

Multi-asset managers have, in the main, said there is more to come from Japan’s equity markets, despite the terrific rally already witnessed.

David Coombs, manager of Rathbone Unit Trust Managers’ (RUTM) multi-asset range, said the initial wave of gains was “absolutely yen-driven”, and caught a lot of investors off guard.

However, the manager said the market remains one of the most attractive on a relative view.

“We have gone overweight the region,” he said. “The market is not cheap anymore, but you should not fight the money flows.”

Coombs said he is disappointed corporates are yet to play their part in Abe’s plans, prompting him to point out the country does not feel like one “on the verge of economic revolution”, but he said, looking across equity markets, Japan remains in favour with overseas investors.

“It is a relative game as most equity markets are now fair value, but Japan has more momentum behind it than, say Europe and the emerging markets, so it makes sense to be overweight,” he added.

Earnings surprises

Martin Gray, manager of the Miton Special Situations fund and Strategic Portfolio, is also expecting more gains in Japan after previously struggling to find investment opportunities in any global region.

Having built up his cash pile because of lack of clear value opportunities in equities, he now sees the potential for earnings upgrades in Japan.

Gray said: “What has happened so far is likely to lead to increased corporate margins, which is going to be positive, so I can see further room for earnings improvements.

“Therefore, in the short term, I am reasonably comfortable with Japan, and it remains our largest equity weighting.”

Gray’s top holding in the Miton Special Situations fund is 4.3% in GLG Japan CoreAlpha fund, and he holds 3.6% in the J.P. Morgan Japanese investment trust.

He also has a range of positions across other portfolios, with holdings including the CF Morant Wright Japan fund and the Japan Residential Investment Company.

Liontrust’s recent recruit John Husselbee, head of multi-asset at the group, has also been allocating to the region, with a particular focus on domestic sectors, noting the tumbling yen has already delivered its boost to exporters.

“The early improvement in the domestic economy and a sharply weaker yen reinforced investors’ hopes of a long-term revival of economic growth,” he said.

“It helped the equity market surge to a six-year high as the economy continues to improve, with a weaker yen supporting exports and increasing consumption. But, looking ahead, global economic growth remains a key factor, along with continuing monetary and fiscal easing, combined with a weak yen.

“As a result, the fund managers we follow say they see better opportunities in the domestic sectors rather than the exporters now.”

Focus on Abenomics

Fidelity’s Alex Treves, head of Japan equities, agrees the yen impact has now largely played out, but said the authorities are aware of this and are acting to boost other areas of the economy.

“The yen is not fundamentally a weak currency, and most central bankers recognise this, so corporates need to do their job now and maintain earnings growth,” he said.

Treves noted P/E ratios in Japan are similar to the US, Europe and Asia, despite the recent rally, meaning there is plenty more for investors to aim for.

“If Abenomics works, then the rally should be sustainable even if the currency stabilises, so there is no reason the Nikkei cannot revisit peaks seen in 2006-2007.”

Comparative returns

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JPY/USD

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