Should investors stick with lagging Japanese stocks?
When the Japanese asset bubble burst in the early 1990s, it triggered a financial crisis which persisted for the better part of two decades.
But when Shinzō Abe – Japan’s Prime Minister – took office in 2012, he came armed with a plan to jolt the country out of its malaise.
Referred to as ‘Abenomics’, his strategy relied on the ‘three arrows’ of government spending, monetary policy and structural reforms to get Japan’s economy growing again.
Last year, it appeared the approach had started to work, evidenced by the fact that Japan’s main equity market, the Topix, rose by a staggering 51 per cent.
Since the start of this year, however, Japanese shares have fallen out of favour with investors, with the Topix down by over ten per cent.
Why so low?
According to the managers of the JP Morgan Japan Strategic Value fund, events occurring outside of Japan spurred some investors to take profits and run.
The managers say weaker US economic data and concerns surrounding the US Federal Reserve’s tapering have contributed to the string of exits. So too has China’s slowing economy.
But they note internal factors have also played a role.
A sales tax hike from five per cent to eight per cent, which took effect at the beginning of April 2014, spooked some investors, while others seemingly cut their positions due to disappointment over the Bank of Japan’s perceived inaction towards the faltering markets.
There has also been widespread concern over Abe’s failure to successfully implement the third part of his plan – structural reform.
The all-important third arrow
Commentators believe these reforms will be the crucial element that will help boost the country’s long-term economic performance.
The labour market, agriculture, female participation in the workforce and healthcare have all been identified as areas in need of reform.
While Abe has made some progress towards implementing these reforms – for example, he has pushed for Japanese participation in the Trans-Pacific Partnership – he has come under fire for the slow implementation of his third arrow.
According to the JP Morgan Japan Strategic Value fund team, the negative commentary could continue to weigh on the stock market.
In January a government panel designated the next three years an “intensive implementation period”, although this government has been criticised for previously announcing sweeping reforms and then retreating.
Straw into gold
Despite the criticism, fund managers stress that Japan provides ample opportunity for long-term investors
Andrew Brown, a specialist in Japanese equities at Baillie Gifford, says: “There is a disconnect between fundamentals and what’s going on with the market. Companies are doing well, they have more money to invest and they’re more confident than they have been in a long time.”
The market contains strong companies at attractive valuations, adds Mark Davids of the JP Morgan Japan Strategic Value fund.
“As a result of the impact of Abenomics, the Japanese stock market rose more than 50 per cent in 2013. Yet in price-to-earnings and price-to-book terms, the market has not been rerated – it is as cheap now as it was 12 months ago.”
In addition, Japanese companies are shifting away from their traditional – and highly criticised – attitude towards corporate governance and instead becoming more “Western”, says Tony Lanning of the JP Morgan Fusion fund range.
Firms are increasingly focused on shareholder value and profitability rather than pursuing market share as they used to, he says.
Brown has been encouraged by wage increases and signs of life in the long-suffering real estate market.
Many base wages have gone up ¥2,000 in a month – the equivalent of £11.29 – and bonuses are also rising. He feels that this increase is consistent with the 2 per cent inflation target set by Abe.
While commentators may be criticising Japan’s leader the JP Morgan team believes that Abe’s popularity with the electorate remains high. This popularity, they say, is allowing him to continue with his pursuit of economic reforms such as special economic zones, free trade agreements and deregulation.
Davids concludes: “There has been an awful lot of talk about the ‘third arrow’ of Abenomics. But while these reforms would be nice to have, the really important thing is the first arrow: Japan is reflating.”