Japanese equities hit 30 year high: Is there more to come?


The Japanese Nikkei stock market closed above 30,000 today for the first time in more than 30 years as the country’s economic recovery from the coronavirus pandemic continues apace.

The benchmark Nikkei 225 surged by 1.9% after Japanese fourth quarter GDP announcements were well ahead of expectations, lifting an already buoyant mood after US equities recorded fresh highs on Friday.

The breaching of 30,000 is a psychological milestone for investors, marking a long road to recovery from its previous high of August 1990 ahead of a massive property-fuelled crash.

The question now for investors is whether Japanese equities can maintain their upward trajectory?

For UK investors, the Nikkei index has been the top performer since the coronavirus began to take hold almost a year ago in late February 2020, but it has gone largely under the radar.

While all eyes were on the US and technology stocks as the big winners of lockdown last year, Japanese equities have quietly powered ahead, rising 28.3% since 21 February (see table below). This is well ahead of US equities, which are up 12.5% over the same period in sterling terms, as dollar weakness eroded returns for UK investors. Both are way ahead of UK, which are languishing down 7%.

Double-digit recovery

The economy is certainly getting back into gear nicely. Official figures show it grew at an annualised rate of 12.7% between October and December, well ahead of economists’ 9.5% forecast. This was lower than the 22.7% bounceback in the third quarter but maintains the strong recovery from the record 27.8% slump suffered in the second quarter, when the pandemic took hold.

Japanese GDP shrank by 4.8% overall in 2020, making it one of the most resilient in the world last year. While lagging its regional neighbour China, announced 2.3% growth last week, the contraction was less than half the 9.9% suffered by the UK.

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‘Asia was first in and first out of the first wave of the pandemic and subsequent waves appear to have been equally well managed,’ said AJ Bell investment director Russ Mould.

There have been several missteps along the way, however. The Japanese government, then led by prime minister Shinzo Abe, was widely criticised for its initial Covid response. It was accused of downplaying the seriousness of the virus, hoping it could still host the 2020 Tokyo Olympic Games.

It responded quickly with financial stimulus though, announcing a ¥117 trillion (£800bn) package in April. An effective track and trace system meant lockdowns were localised, rather than national and despite its very large elderly population, Japan has recorded under 7,000 coronavirus-related deaths. Although low by European standards, this death toll is high compared to Japan’s Asian neighbours and the government, now headed by Yoshihide Suga, who replaced Abe in September on health grounds, has faced fierce domestic criticism.

Reforms paying dividends (literally)

Keeping the economy largely up and running through the pandemic was a significant short-term factor driving Japanese equities’ performance in 2020. But there is also a growing recognition that the country’s multi-year programme of structural reforms is bearing fruit.  

Abe came to power for the second time in 2012, introducing his ‘three arrows’ of economic reform: aggressive monetary easing, increased government spending, and an overhaul of corporate governance.

The ambitious program was designed to make the country both more competitive and attractive to foreign investment by improving corporate governance. Abe sought to sweep away Japan’s reputation of being home to giant, unprofitable conglomerates, with the reforms increasing the focus on capital efficiency and improving shareholder returns, for example by paying dividends.

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‘The first phase addressed low lying fruits with companies reducing surplus capital via higher dividends and share buybacks,’ said Keita Kubota, head of Japanese equities at Neuberger Berman.

‘We are now in the second phase where management is addressing issues tied to long-standing business traditions such as cross-shareholdings with its lenders, clients and supplier as well as reorganising business portfolios and letting go of non-core assets to improve capital efficiency and resource allocation across the company.

‘These are significant moves from a Japanese business culture perspective as these were long-standing structural issues that were previously considered sacred ground due to legacy management reasons.’ 

Archibald Ciganer, manager of the T Rowe Price Japanese Equity fund, says ‘early indications are reassuring’ that Suga will build on Abe’s reformist agenda.

An upcoming revision to the corporate governance code will introduce greater independent oversight into boardrooms, expanding the role of non-executive directors. At the same time, the Tokyo Stock Exchange is tightening the rules on corporate governance in an updating of its listing rules.

He also points to the creation of a new government department, the Digital Reform Agency. It has been tasked with promoting the adoption of technology, increasing the use of artificial intelligence (AI) and robotics, and shifting business to the cloud to improve corporate efficiency and profitability.

For Ciganer, this all points to a positive outlook for Japanese equities, which he believes are ‘under-owned’ by international investors.

‘With Japanese companies having strong cash positions and corporate governance standards continuing to improve, even as profits have come under pressure, the asset class is an attractive investment proposition, in our view, and trading at a discount to regional peers,’ he said.

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‘We continue to believe that Japan is a compelling active management case, particularly as the market is under-owned and displays positive change dynamics.’

Analysts’ top Japan fund picks

Despite the strong performance of Japanese equities in 2020, they certainly didn’t capture the imagination of UK investors. Over the year, £38.2m was pulled from Japan funds, according to the Investment Association.

For anyone looking to dip a toe into the asset class there are plenty of options.

Rory McPherson, head of investment strategy at Punter Southall Wealth, highlights the RWC Nissay Japan Focus fund as a favourite pick in the sector.

‘This is a fabulous way of tapping into the changing corporate culture in the Japanese market. With just 21 stocks in the portfolio, the manager takes a highly active approach, engaging with companies on their journey to being more shareholder friendly and tapping into the ageing demographic evident in Japan,’ he said.

The fund has investments in healthcare and technology, with McPherson adding it ‘is an excellent way to get good quality and fast growth in a low growth economy’.

Charles Stanley investment analyst Rob Morgan opts for a ‘high octane’ investment trust, Baillie Gifford Japan (BGFD), to gain exposure.  

‘The trust’s managers target companies that enjoy sustainable competitive advantages in their respective industries and are capable of growing earnings and cash flows at a faster rate than the market average,’ he said.

‘It is a differentiated and higher octane option in the area and captures many of the growth areas available among Japanese corporates. The focus on growth results in a higher risk collection of holdings, which is exacerbated by gearing of up to 20% and an ability to invest in earlier-stage unlisted companies.’

 

 

 

 



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