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In a week when America’s largest technology companies were helping to propel the S&P 500 Index to yet more record highs, investors in Japan might be excused for feeling a bit left out. The Japanese stock market trailed markets in America and Europe last year and it’s begun 2020 on a weak note as well¹.
Yet Japan remains home to an impressive array of successful car, technology and industrial machinery companies. With electric cars and new technologies for the home and business currently very much in the ascendency, why is Japan not doing better? With the world set to descend on Tokyo for the Olympics in July, you might have thought investors would be more upbeat.
The view from the top is Japan has demographics and cultural challenges that aren’t going away anytime soon. An aging population with growing healthcare needs and a culture more predisposed to saving than shopping are a dire combination for the nation’s finances.
At least one of these problems showed up in news this week that the economy shrank by 1.6% last quarter, with domestic consumption and business investment falling about twice as fast². A major factor appears to have been the government’s decision in October to finally bite the budget deficit bullet and bounce VAT up by 2% to 10%.
In light of weakness in Japan’s consumer economy after previous VAT rises – like the last one in April 2014 – the hike had been delayed several times. But eventually the government had to move its plan forward. It had hoped the introduction of a cashback reward points system for consumers would have softened the blow³. Maybe it did, but clearly not to the extent planned.
One encouragement for Japan is that the world has moved on, and not in a good way. Japan is no longer the only major country wrestling with weak consumption trends and below-par growth and inflation. In a Japanese context these have been par for the course for the best part of three decades but, for now at least, Japan no longer treads this pathway alone.
The eurozone – the world’s other major home to negative interest rates – is also struggling to make economic headway. It, like Japan, has been hit by US-Sino trade tariffs at a time it can ill afford to.
The charitable view is that not all of Japan’s current economic weakness has been home-grown and that improving conditions globally – following a series of interest rate cuts in the US in 2019 – will soon start to feed through. Certainly Japan has historically shown a high sensitivity to global trade.
A reason for cautious optimism too is that the latest blow to the economy could cause the government to redouble its efforts to stimulate growth.
The “Abenomics” applied to the country since Shinzho Abe became prime minister in 2012 – a combination of more government spending, low interest rates and structural reforms – may have helped to lift the economy away from deflation without propelling it to anywhere near its full potential.
However, Japan’s parliament passed a broad package of stimulus measures in December – the first time it has done so in three years⁴. Now, just as stimulus hopes propelled Chinese stocks higher last year, Japanese shares could benefit from increased prospects for further measures.
Investors venturing into Japan today will find they do so at a price that, based on company earnings, is about a third cheaper than world markets generally⁵. That – along with record corporate cash piles – is perhaps one reason why Japanese companies like Sony, Toyota and SoftBank are already big buyers of their own shares⁶.
However, undemanding valuations are nothing new. For some long time, Japanese world leaders have been available to investors at attractive multiples of the earnings they make.
What Japan needs now are catalysts to improved investor, business and consumer confidence. The Tokyo Olympics and the boost to tourism that will bring may end up being one, while a pickup in world growth could be another.
In the meantime Japan looks set to continue to offer an attractive counterbalance for investors exposed to world markets currently trading on more demanding valuations, notably the US.
Historically Japan has proven a rich hunting ground for funds able to seek out and invest in companies making the most of the prevailing opportunities. The Japanese funds featured on Fidelity Select 50 list are “stock pickers” but with varying investing styles.
The Baillie Gifford Japanese Fund has a longstanding position on the Select 50 list and benefits from the largest team of investment specialists outside Japan. The Fund focuses on leading Japanese companies offering attractive and sustainable earnings growth. It currently has large holdings in the technology conglomerate SoftBank, the asset manager Sumitomo Mitsui Trust and the oil company INPEX. Sony also makes it into the Fund’s current top-10 holdings⁷.
The Lindsell Train Japanese Equity Fund is a relative newcomer to the Select 50 list. It focuses on companies with a high and stable return on capital and low capital intensity. It is far less exposed to businesses dependent on improvements in the Japanese economy than some others.
With just 23 separate holdings at the end of last month, it has a relatively concentrated investment portfolio. Large investments currently include Kao Corp – often considered the Proctor & Gamble of Japan with its extensive range of personal care, cosmetics and cleaning products – Nintendo and the multinational drugs company Astellas Pharma.
A recent addition to the Select 50 is the Man GLG CoreAlpha Fund. It is the most value oriented of the three funds here and starts out by focusing on Japan’s top 300 companies trading on low valuations. Current large holdings include some internationally familiar names including Honda, Toyota and Canon.
¹ Bloomberg, 19.02.20
² Cabinet Office, 17.02.20
³ FT, 01.10.20
⁴ The Japan Times, 05.12.20
⁵ MSCI, 31.01.20
⁶ Bloomberg, 03.09.19, and Toyota Motor Corporation, 05.02.20
⁷ Baillie Gifford, 31.12.19
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy funds. Equally, if a fund you own is not on the Select 50, we're not recommending you sell it. You must ensure that any fund you choose to invest in is suitable for your own personal circumstances. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
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