Emma Wall: Hello and welcome to the Morningstar series; Why Should I Invest with You. I am Emma Wall and here with me today is Chris Taylor, manager of the Neptune Japan Fund.
Hello, Chris.
Chris Taylor: Okay. Good morning, Emma, and nice to see you. Thanks for inviting me along.
Wall: Over the last 15 months a lot has happened in the Japan market. I thought we had start by recapping last year. It seems you needed to be a fool not to make money in Japan last year.
Taylor: Well you can look at it that way. But the brutal truth is there were two big changes in Japan. One is being long term, which is just the reorientation of the Japanese industrial base away from being exporters to true global multinationals, and that was driving earnings growth anyway. So you had a very good fundamental background. However, the yen's strength had screened that development and it was really as a result of the second change which is the political one. You finally have a group of individuals in charge, who understood the only way to save the country from bankruptcy is basically to trash the yen, to boost corporate profits even more, to get a big corporate tax receipt, which eventually pays down the budget deficit and the debt.
Wall: I mean Japan over the last 10 years there have been these periods of sort of stock market growth and then falling, stock market growth and falling. Last year everybody said this is going to be the last one, they were just going to go and go and go and then the last couple of months that's fallen apart and The New York Times saying that Japan has lost its ‘darling status’ this week. What's happened, what's gone wrong?
Taylor: Well I think that reflects the impatience of The New York Times rather than anything else. The brutal truth is, they have put in very dramatic policies last April and the market rose in anticipation of the fact that this would hopefully begin to work. And in truth, if you look at a lot of the fundamental indicators, the employment, wages, et cetera, it is. Maybe it's not happening as rapidly as Americans would like, but the point is they do seem to have turned the corner.
And the reality of it is, focus on the earnings growth, because that's what's going to drive things higher. In the short term, to be honest, this first quarter, remember everybody got very miserable, very quickly, because American economic figures disappointed, because they forgot about eight-foot deep snow in places where you don't normally get snow. And then at the same time you had China slowing down a bit, which is unsurprising, given they are trying to rebalance away from investment-consumption.
And both of these things hit at the same time and just took the edge of Japan. And to be honest, if you are a Japanese you made 50% odd in the market. March 31, which is coming up, is the financial and tax year end. So there's a natural bout of profit taking and that's all it amounts to. The fundamentals behind the Japanese story are fine. The earnings growth is still there. We are about to walk into the reporting season.
And to be blunt it works a bit like America did under Bernanke. Bad news is good news in the sense that all they would do is up the Q/E program, borrow and spend more money, increase the monetary base and trash the yen again. So, if there is any wobbles, that's exactly what they will do.
Wall: Well how dependent is the market on foreign cash? $155 billion went into Japan's stock market last year; $12 billion has come out so far this year. Is that just profit taking or is that a sign of things going a different direction?
Taylor: Yes. To be honest most of the money that went in was foreign money, most of it American. Sadly U.K. and European institutions actually managed to put in less money than they did during the first quarter of 2011, just before the earthquake and tsunami. So it's just again, I would argue American impatience is mainly driving the money that's come out. And they have reasons not to like it and to take profits, which, again gets back to the U.S. and Chinese economic figures because they have done terribly well.
If you look at some of the American funds, there was a – this is an advert for a competitor – WisdomTree Hedged ETF, went from $800 million to $24 billion in nine or 10 months and the Morgan Stanley Hedged ETF Japan, went from a standing start to about $12 billion. So it was very heavily concentrated firepower, and likewise when it comes out its equally as concentrated. But to be fair the Japanese domestic investors back through their tax ISAs, which are a knock off of our ISA schemes.
The only trouble is that – as ever, Japan's bureaucracy managed to slow things up a bit, because they have only approved 1.4 million accounts and they have got best part of five million backed up. But in January alone they put in $14 billion against $17 billion coming out. Now slightly different stocks to the ones that were being sold, but you have got that background firepower coming in now. So it will offset the bulk of sales from here on in.
Wall: So what then can a U.K. investor in the Japanese stock market expect going forward?
Taylor: Well it looks like the core run rate of earnings in Japan is 20%, 25%, assuming no currency move and nothing dramatic happening. And the currency ends up being a topper. This is one of the fundamental problems in Japan. People just do not realize how good it is. Because if you look at the TOPIX Index, if you use standard or consensus average figures, they are predicting for the year ending March 31 this year. They are predicting only about 26%, 27% earnings growth.
Now if you look at it, the minimum is 55% on a cash flow basis and it actually goes to 84% on a net profits basis. And this is one of the big issues with Japan. After a 30 year bear market there is almost no broking capacity. So the breadth and depth of the research on Japan in total is God awful. And it's particularly poor when you start looking at anything other than the very biggest stocks in Japan.
So obviously to be blunt, even if they knew what they were talking about, and did the analysis properly, there aren't enough people to disseminate the news properly. And this is why people just don't appreciate the strength – the breadth and strength of Japanese corporate earnings.
Wall: So good things to come.
Taylor: Yes. Just sit tight, to be honest. Buy now for Christmas.
Wall: Chris, thank you very much.
Taylor: Okay, pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
