After a 50% rise in 18 months, William Bourne looks at the future for Japanese equities
In September last year I came off the fence on the side of the bulls in Japan. I pointed to the likelihood of another four years of Abenomics to wear down any opposition at the Ministry of Finance, the revival of the Chinese economy and a change in monetary policy to target the yuan rather than the US$.
Four months later, the market is up around 50% in yen terms since mid-2016, and the very smallest companies in the JASDAQ index by much more. It is time to review how much further Japanese equities might rise.
It is clearly one of the cheaper of the developed markets, with an average TOPIX price to book of around 1.4x (half the US S&P 500 index at 2.8x), but that alone is not sufficient. Value has had a rough near decade in the QE environment and while that trend may have ended it has not obviously reversed.
There are some encouraging signs domestically. I have written before about the gradual renormalisation of risk-taking - call it the return of animal spirits if you like. That seems to have spread to the financial markets, with domestic investors once again raising equity weightings. The Deputy Governor of the Bank of Japan in November 2017 called for ‘fair remuneration for financial intermediation services’, which is banking to you and me, to prevent a collapse of the financial system.
I would suggest that the two largest influences, however, are outside Japan. The first has to be China. Japan’s relationship with China is multi-dimensional: on the one hand it is deeply connected economically as an investor and as a supplier of intermediate goods; on the other is the stand-off between the first and second regional powers, typified by the dispute over the Senkaku/Diaoyu islands. I would argue that both are positive for Japan’s corporates: on the one hand Japan will share from the Chinese recovery; on the other defence spending is rising steeply.
The second is the path of global interest rates. This is more nuanced but if the trend to higher rates rises we can expect investors’ appetite for duration, whether in bonds or equities, to fall. In such a case, Japan’s low valuations will be more attractive relative to other markets. I accept that does not necessarily mean a higher market level and it may simply mean that Japanese equities fall by less than other markets. However it almost certainly does mean a swing back to value at the same time and that is where Japanese equities score highly. So I remain on the front foot.
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