5th August 2013
Both the Japanese and Chinese economies remain good investment prospects argues Thomas Becket, chief investment officer of Psigma. But the multi-manager has also warned that despite a positive long term appraisal for China’s shares, the world will have to get used to growth as low as 5% as the economy rebalances.
In a note issued this week, following a trip to Asia, Becket also argues that the Japanese shares recovery could have a long way to run.
“The recent market recovery since the May ‘mini-crash’ reflects an improving confidence at both a consumer and corporate level. Where once there was a sense of doom and depression, there is now hope. This is an amazing change. Previously, Japanese fund managers desperately tried to sell you their ever-shrinking funds on the basis of extremely cheap valuations; now they convincingly talk of a renewed sense of activity in the Japanese economy, long overdue reform and pent-up demand. Our conclusions were that we remain very bullish on the medium term outlook for Japanese equities.”
However, while the first two arrows of reform – looser monetary and fiscal policy have hit the target, Becket argues that it is the third arrow – structural reform – which will eventually determine the success or failure of Abenomics named after the Japanese PM Shinzo Abe.
“The success of the third – long overdue and desperately needed – structural reform will determine the success or failure of “Abenomics”. Extraordinarily, for once we have confidence in a Japanese politician. The view on the ground in Tokyo was correctly that Abe-san and his allies would romp the Upper House election last month and therefore have a 3 year unopposed mandate for change. Sensible policies have already been mooted and will be a step in the right direction.
“The economy itself is definitely starting to warm up, primarily led by consumption, but followed now by improving industrial production and manufacturing, despite softening global demand. Domestic companies, many of whose profitability has been boosted by the weak yen, have been tentatively adding to capital expenditure and are starting to boost wages, as Abe-san has demanded. Tax breaks on business investment should help this further. Importantly, confidence and cash has started to drip from Tokyo to other regions in Japan, broadening the economic revival.”
Becket argues that even with a 70% rally, it is hard to argue that Japanese equities are overvalued.
“Even after the 70% rally we have enjoyed from Japanese equities since last November, when Abe-san came to power, we don’t think it is too late to be looking for opportunities in Japan. From a valuation perspective it is hard to argue that Japanese companies are expensively valued and there remains the potential for a long term growth surprise, which is under appreciated by investors. Indeed, if Abe-san is successful in weakening the yen further then Japanese companies could still be very cheap. We also think that the high levels of scepticism from many global investors and under-ownership of Japanese equities could lengthen this rally substantially.
Fund managers who have refused to consider investing in Japan on the understandable basis of two decades of barely interrupted pain are now feeling the heat of a market that has soared from the November lows and is up nearly 40% this year. There are obvious risks to the implementation strategy of Abenomics and it would be naïve to suggest otherwise, but we believe as great a risk could be resisting the temptation of owning a healthy weighting in Japanese equities.”
He says his favourite fund picks are Jupiter Japan and Lazard Strategic Japanese Equity.
Becket also visited Hong Kong to get views on China and suggests that the world may have to get used to Chinese growth at around 5%.
The note continues: “It was obvious by the end of our trip that many economists are right to be worried about recent economic data points and the rumblings in the Chinese financial sector. Perhaps our most interesting conclusions were that the world is going to have to get used to a new level of Chinese GDP growth of circa 5%, a long way down from the heady levels of 10% growth enjoyed in the last decade. Despite this reduced economic power, many Chinese equities are very cheap and we believe a great long term opportunity is on offer.”
“There is plenty of confusion being generated by the new government. Although we know that the new administration’s aims are to rebalance the economy, usher in financial market reform and ease levels of social discontent, we don’t know how they will do this. Even the keenest and most connected political experts depart Beijing guessing at the plans.”
The note says that while they deliberate over their plans, it is clear that the economy is slowing down more quickly than expected, with consequences for Chinese equities and global resource companies. He says there may be worse to come for the economy and by implication resource-rich countries such as Australia.
All the while they deliberate over their plans it is clear that the economy is slowing down far more quickly than most expected, which has triggered another very poor year for Chinese equities and global resources companies, who had become dependent on the hungry Dragon’s supposedly insatiable appetite.
“If the Chinese government are serious about shifting the growth model away from fixed asset investment towards services and consumption, as we feel convinced they are, then there will have to be a period of re-adjustment and this will bring greater short term uncertainty over growth. This will require patience from the Chinese government, citizens and global investors. On the positive side, in the longer term, the economy should be better balanced and growth more sustainable.”
Becket accepts that Chinese banks may have to be recapitalised but that this may be a cathartic event.
“There are also huge fears in the West about the pending implosion of China’s financial system, brought about by the shadow banking system and insane wealth management products, including a bond which has been backed by ham. (Yes, that’s ham the pork product). Our key take-away was that the Chinese authorities recognise the issue and are moving to address it. The worst case scenario that is loved by the western press is unlikely, but undoubtedly losses in the banking sector are going to rise. There is certainly the possibility that the banks will have to be re-capitalised, but that will be manageable in a closed economy. Indeed, we think that when the problem is finally dealt with properly and the losses are acknowledged it should be a cathartic event.”
Even with this backdrop, however, Becket remains bullish for Chinese equities.
“So how can we possibly claim that the uncertain backdrop I have described is good for Chinese equities? In the short term it probably is not and there is a fair chance that the next three months will prove tricky and volatile. However, we would argue that two years of negative performance and a material de-rating of Chinese stocks has now factored in a very bearish scenario. Even if you take the lowly rated banks out of the equation, then the Chinese market trades on a lowly 8xs price earnings multiple. Add in the banks and it is around 7xs. Totally hated, generally distrusted and widely shunned by global investors, Chinese equities could prove to be a classic contrarian trade and could well be one of the best places for returns in the remainder of the decade.”
He says his top pick in China is Allianz China and we also own an Asian fund from Schroder (Asian Income Maximser) and in emerging markets from Mirabuad (Mirabaud Emerging Markets).
In conclusion, the note says: “Although they are stances that many investors might find awkward, we believe that the momentum in Japanese equities can continue and a value opportunity is ripe for picking in China. As with all investments these days, these two investment opportunities are likely to be volatile but we think they will be very rewarding.”