This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Becket, Chief Investment Officer, Psigma Investment Management urges investors not to forget the Japanese rally.
In amongst the terribly tedious 'Taper' debate, the excitement over the long overdue return to growth in the Eurozone and the 'Great Deceleration' in the Emerging Market economies, the major story from the first half of the year has been ignored; Japan. After the early fireworks and extreme volatility in Japan, the last few months have been notably quiet. Despite its removal from the front page, the Japanese market has delivered excellent gains again this quarter, which have benefited portfolios, as long as you hedged the currency.
In politics there are clear signs that Prime Minister (Super) Abe-san has come back from the summer recess with the bit between his teeth and he seems determined to push on his with his plan to blast Japan from its slumber. His diary is full of plans to reform Japanese politics, taxation and the corporate sector; all necessary steps that have been too long in coming. Our take is that Abe-san recognises that the original shot of the 'reforming' third arrow from his bow was limp and failed to hit the target. He is keen to ensure that the next attempt is far more potent. By the end of October and following the consumption tax decision, we will have a fair idea of whether he will be successful.
In the corporate sector we have been delighted with the progress that Japanese companies have made in 2013. Profitability has soared, as operational leverage has boosted earnings. The weak currency has also helped boost short term profits. The longer term outlook is obviously more challenging, but with domestic confidence growing, global trade solid and the global economy likely to reach long term trend growth in 2014 for the first time since 2008, there are reasons for optimism. The key missing link has been rising wages, but again our Japanese sources insist that this lumbering wheel is starting to turn and this should add to the domestic consumption theme.
Consumption was the first part of the recovery jigsaw to be fitted, as loyal citizens followed their leaders call to spend. Although this has softened recently, there seems little doubt that confidence is on a decisively improving trend. This can only have been helped by the recent win of the 2020 Olympic bid. This has (rightly) been taken as a vote of confidence in Japan and has been a big boost to the country's self-belief and the spending will help grease the cogs of the country's economic engine and aid the nascent recovery in Japan.
Our biggest conviction call this year has to be aggressively weighted in Japanese stocks with the currency hedged. This has not changed and we remain optimistic about the next few years, as long as Abe-san follows through on his early promise and companies start to spend their mighty cash piles. However, achieving similar returns to 2012 and 2013 will be very difficult next year, but we still feel that the Nikkei can glean a 10-15% return and build on our 2013 year-end target of 16,000. We take comfort from the legions of naysayers and unbelievers and the fact that portfolios, for reasons from the fair to the ridiculous, still remain scantily exposed to one of the world's biggest stock markets.
