9th April 2015
Japan has been a bit like Marmite for investors since the start of Abenomics writes Kerry Craig, global market strategist at JP Morgan Asset Management…
The ambitious suite of stimulative economic policies inspires dedicated faith from investors who believe in its power to reverse decades of deflation, whilst others are more likely to dismiss its potential and instead loath the prospect of yet another false dawn.
However, a belief in the success—or otherwise—of Shinzo Abe’s plan to reignite the economy may not be the right investment thesis for Japan. There are other reasons why equity markets may continue to move higher. The country’s deep-seated economic challenges should make any long-term investor stop and think, but a few things are starting to swing in Japan’s favour and the market may well be worth another look.
The most obvious attraction of the Japanese market is the price. Compared to many other developed markets—and its own history—it looks cheap. Even though the Nikkei 225 is up 13% so far this year, and 180% since its low in March 2009, the current forward price/earnings ratio of 18.9x is below the average of the last 15 years of 21x.
Marmite haters will say that it is just the weaker currency and not a genuine improvement. However, unlike 2013, when market gains were accompanied by a significant depreciation in the yen, this year’s gains show no more than enthusiasm based on central bank balance sheet expansion. In fact, there could be a combination of factors at play.
Japan had the strongest earnings momentum of all three major developed regions in the last quarter of 2014. What’s more, some 67% of TOPIX companies beat earnings expectations— the highest level in five years—and if we exclude energy companies, earnings per share grew at 8% year on year. This week’s chart shows that more companies are seeing their earnings outlook for the coming year revised up than down.
Japanese equities should benefit from continued support from official institutions as the Government Pension Investment Fund (GPIF) needs to invest $ 59 billion in Japanese equities to achieve its target of a 25% equity weighting. The Bank of Japan (BoJ) is also looking beyond bond purchases and is expected to invest $25 billion in the domestic equity market as part of its programme of qualitative and quantitative easing. But the secondary impact is just as important. Even if a small portion of the $4.8 trillion invested in the domestic pension fund and insurance industry follows the money from the GPIF the effect could be quite significant.
Both the BoJ and GIF are investing through a newly created index, the JPX Nikkei 400 Index, which comprises companies meeting certain investment standards such as return on equity and corporate governance. The investments will be published and should encourage companies that are not part of the JPX Nikkei 400 Index to improve their corporate governance and put greater emphasis on shareholder returns.
Japan imports more energy than most developed economies, at 3.6% of its GDP, but this means that it has the most to gain from the fall in the oil price, even when considering that cheap oil leads to disinflation, which is what Abe is trying to prevent.
There have been too many false dawns in Japan for any investor to consider its equity market to be a sure thing. Given the depth of the country’s structural problems, it’s admittedly too early to judge whether Abenomics is working. But the Japanese equity market has had an excellent start to the year and there are several reasons to think that it will be supported in the medium term: attractive valuations, decent earnings momentum and continued structural support from official sources.
The idiosyncrasies of the Japanese market may also hold some attraction for global investors hungry for diversification. Over the last three years, the MSCI Japan Index has had the lowest correlation with global equities of any of the major developed markets.
So love it or hate it, Japan could continue to be one of the better-performing developed equity markets this year.