This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Becket, CIO of PSigma Investment Management, considers the future of Japan.
Delays, stuttering service, scant information; it would never happen on Japanese railways. But the aforementioned issues are symptoms that have been plaguing the Japanese equity market.
A strong US is traditionally good news for Japan
Indeed, after a dreadful start to the year, Japanese equities are now in correction territory, with Tuesday’s massive 4% fall on the Nikkei taking the year's losses to 15%. Japanese stocks have clambered off the canvas in recent days, but are still firmly in the red for the year.
In our view, the two main knocks to Japan's market have come from over-confidence of investors, leading to an overdue and healthy correction, and the strength of the yen. As you will have read in the myriad of comments over the last few months, our once lonely position in Japanese equities had become very crowded; hopefully the recent sell-off has blown some of the froth from the trade and knocked out some of the “hot money” investors.
The yen strength has really been attributable to two factors; the emerging market 'crisis' and patchy economic data from the US. In the first instance the yen has been a beneficiary of safe haven flows and in the latter it has followed its usual path of falling in tandem with US Treasury yields. A strong US is traditionally good news for Japan.
We also think it is a case of no new news being taken as bad news. Economic data has been OK, but unsurprising. We watch the forthcoming GDP data with keen interest. The direction of Abenomics and the much-needed structural reform has also been stuttering. However, the meeting with the Tokyo-based manager confirmed that the Abe administration had already made great leaps in the energy, trade and tax areas, with many more reforms to follow, including the forthcoming close to the inaugural ISA season and progression into the Trans Pacific Partnership. Also in line with expectations but not surprising to the upside, Kuroda-san has kept his weapon firing straight at the Bank of Japan, but has yet to add more potent ammunition.
Where we have been pleasantly surprised is with corporate profits. The ongoing results season has been strong, justifying the move higher that stocks made last year. Indeed, Japan was the only market to really “deserve” its leap higher last year, as the rise in profits from late 2012 to the end of 2013 was c.70%, matching the rise in the market. This means that (in simple terms) Japanese stocks are as cheap now as they were in November 2012, with arguably less tail risks, than they were before the rally commenced. Therefore, our views have not changed. We expect Japanese equities to finish the year higher, which equates to a decent rally from here. Japanese stocks should again track corporate profits higher, with our expectations of 15% year over year profits growth. Abe-san and Kuroda-san will do all they can to spur the economy higher and (regardless of international opinion) the yen lower. At the same time, institutions with Japanese funds tell us of record levels of interest from long term institutional investors, which can help to elongate the Japanese market recovery.
In short, the game is not up. Unlike our trains, the Japanese market and economic recovery is on track and on time. The market has taken another mighty whack (akin to May 2013), but we remain bullish of Japanese stocks and have confidence in Abenomics.
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