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An improving tone on trade from Washington ahead of talks later this month between the US and China will surely be welcomed in Tokyo. As one of the world’s great exporters, Japan benefits greatly from free trade and certainly has no desire to become the next on the list for a trade salvo from America.
Meanwhile, Japan faces longstanding structural challenges that act as a drag on growth and development. First among these is a national debt mountain, driven by previous attempts to jump-start the economy with public works spending as well as an ageing population and a commensurately shrinking workforce.
Since Prime Minister Shinzho Abe came to power six years ago, Japan has repeatedly attempted to begin closing the gap in its public finances. The chief weapons have been gradual increases in VAT and policies aimed at lifting economic growth and inflation. The latter would naturally help to erode the value of the national debt, while the former two would help pay the nation’s bills.
In fits and starts, the Abe government has made progress in the right direction. However, accessing Japan’s true economic potential still proves frustratingly difficult.
That’s why Shinzho Abe’s announcement that Japan now plans to open the door wider to foreign blue-collar workers has the potential to end up being a game changer1. Immigration could help to lift growth and inflation and reduce the national debt. As it stands, with no shortage of customers for its portfolio of high quality exports – famously cars and electronics – and the social care needs of its population increasing, Japan now faces serious worker shortages across a number of sectors.
From a manufacturing perspective, the situation could become even more acute, as Japanese companies seek to exploit their undoubted expertise in technologies related to electric and driverless vehicles as well as the continuing automation of the world’s factories.
Barriers to entry for foreign workers will remain, but at least the government now seems set on addressing the problem. Barriers, some more intractable than others, include a culture that remains far removed from western traditions, a language foreigners find difficult to grasp and resistance to immigration among sections of the public keen to uphold Japanese traditions.
One thing investors in Japan will be less concerned about is the current relationship between growth and interest rates. While rising US rates drive concerns elsewhere, the Bank of Japan continues to pursue a policy that is decidedly helpful to companies and consumers.
At its policy meeting last month, the Bank opted to leave its key rate unchanged at -0.1% and press ahead with its post-crisis programme of buying up Japanese government bonds2.
That’s great for Japan’s legions of global exporters, because it helps maintain downward pressure on the yen, making Japanese goods and services more internationally competitive. It also helps to push inflation further into the blue by propping up the prices of imported commodities and finished goods.
Japan has continued to struggle to achieve its target of 2% inflation even under Abe’s expansionist programme. Positive inflation is a prerequisite to persuading reticent domestic consumers to spend more and allowing Japanese companies to consistently raise their prices. Despite continuing economic growth, last month the Bank of Japan revised down its inflation forecast slightly for this financial year and next to, 0.9% and 1.9% respectively3.
Mangers of the respected Baillie Gifford Japanese Fund maintain that investors pay little or no growth premium when they invest in Japan, and they certainly seem to have a point4.
The recent lacklustre performance of the stock market belies low valuations – about 25% lower than for world markets generally – and positive momentum in corporate earnings – the annual profits retained by Japanese companies has hit another record high this year5.
For these reasons, plus the added possibility of meaningful structural change, Japan remains an attractive place in which to invest. Reasons to be cautious include an ever-present chance the yen will strengthen – it has a “safe haven” reputation during times of market stress – and a large consumer cohort, so far, still more inclined to save than spend.
Japanese funds on Fidelity Select 50 list aim to deliver capital growth over the longer term. One of these, the Schroder Tokyo Fund, is currently focused on manufacturers, especially those exploiting new technologies, as well as companies benefiting from structural change in Japan’s domestic economy. At the end of last month, Toyota was the Fund’s largest holding, followed by the banking group Sumitomo Mitsui and KDDI, a large mobile telecommunications operator.
The Baillie Gifford Japanese Fund, which benefits from the largest team of Japan specialists outside Japan, also has top-10 holdings in Toyota and Sumitomo Mitsui, but Softbank – the multinational holding conglomerate that bought ARM Holdings in 2016 – the financial services company SBI, and INPEX – Japan’s largest oil & gas producer – are its top three.
1 Reuters, 02.11.18
2 Bank of Japan, 31.10.18
3 Bank of Japan, 01.11.18
4 Baillie Gifford, October 2018
5 Ashai Shimbun, 04.09.18, and MSCI, 30.09.18
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