Industry March 2015

Value to be found in Japan

Emerging from a recession

  • Japan is one of the cheapest financial markets globally
  • Labour mobility, participation of women in workforce need focus
  • 1% of household savings should be shifted to equities

Is Abenomics on the right track? Can Japan dispel the doom of deflation and finally raise the country out of its missed decades? The jury may be out, but there is a lot of positivity in and around the country’s major cities.

The three arrows of fiscal stimulus, monetary easing and structural reform have been received with some false dawns and varying degrees of skepticism. However, recently Japan officially left the recession.

Due to higher exports, the economy was growing at an annualised rate of 2.2% in the final quarter of 2014. Toyota Motor Corporation declared its highest earnings to date: a net profit of ¥1.73trn, which is a 13.2% year-on-year increase. So, what can we expect in 2015 and beyond?

With Japan’s outstanding general government debt now twice the size of its GDP—a ratio currently the highest among major industrial countries—the country raises concerns in global economic circles.

That said, with the determined position adopted by Prime Minister Shinzo Abe and Haruhiko Kuroda, governor of the Bank of Japan (BoJ), some are less pessimistic than others.

For instance, the recent announcement that the Japanese pension fund would more than double its allocation to domestic equities is likely to be very positive for the Japanese stock market. At the time of writing, the Nikkei 225 is closing in on a 15-year high, having risen 108% since Abe was elected in 2012.

The delay in a further increase in the consumption tax rate was a good economic and political decision. While providing more time for the experiment to work, it does not cut off momentum at its knees, allowing the equity market bull run to continue.

Structural reform is probably the most contentious arrow of the three. There is no doubt this is a complex issue with many moving parts. None of these are instant game changers, for it is the sum of the changes that will create the improvements so desperately required.

A weakening yen and the return of positive inflation, coupled with increased consumer spending from wage–price inflation—which has yet to be seen—should support the demand for equity securities.

With the fall of the yen, imported inflation, export competitiveness and the repatriation of foreign earnings, Japan scores as one of the cheapest markets globally. The 2015 forecast from the BoJ is for strong earnings growth at a rate of 8% to 10%.

There are obvious signs of a work in progress. Labour mobility still needs to be improved and the participation of women in the workforce needs to be increased. This is very apparent—perhaps particularly in foreign circles—given that the Tokyo 2020 Olympic and Paralympic Games is but a short time away.

In addition, corporate tax rates are high, and Japanese corporations, while having a lot of cash on their balance sheets, show no signs of distributing it via dividend payments. What is more, many firms continue to keep people employed in unproductive capacities, which is clearly not in the interests of a sound economic plan.

The obvious risks for Japan are that the inflation target is not met and consumption grinds to a halt. Demand would fall, supply increase, and prices come down.

There is also the risk of there being an earthquake similar to, or of greater intensity than, the Great East Japan Earthquake on 11 March, 2011. This would probably result in a significant decrease in the value of the equity market but, depending on the severity of such an event, it might be followed by a swift rebound.

While it might appear insensitive, buying on the dip is obviously the time to do so. As with any investment, you make money on the price for which you buy the asset, not on that for which you sell it.

It is worth noting that Japanese households hold 53% of their assets in cash compared to 15% in the US. The desired shift of 1% from household financial assets to domestic equities over the next five years would add ¥18trn in new funds to equities. Until such time as this objective is achieved, the BoJ has committed to a bond-buying programme.

Nobody can say with any certainty what the outcome might be, but the Japanese corporate sector does offer an attractive investment opportunity over the medium to long term.

The information contained in this article is believed to be reliable, but is subject to change without notice. It provides an opinion, based on facts and experience, and is not to be construed as investment advice. deVere Group makes no representation as to the completeness or accuracy of the information or of any opinions expressed.