Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
It’s 30 years since Japan’s Nikkei 225 Index was last trading at levels over 30,000. Back then, Japan’s stock market was passing through this level on the way down from a record high of almost 39,000, reached in December 19891.
In very different times from those we are living through today, Japan was then considered to be the number-one challenger to American economic dominance. China was still an emerging market of lesser importance – well off the radar for most investors, even global institutions. Computers sparsely populated offices, but few of them were connected to the worldwide web.
The present rally marks Japan’s emergence from the latest in a long line of recessionary phases since higher interest rates burst an immense asset bubble at the end of the 1980s. The remarkably long intervening period between 1989 and today spans a period in time during which Japan struggled against an unrelenting tide of deflationary pressures, sluggish consumer demand, bad debts from previous excesses, the reform of outdated corporate structures and the financial pressures invoked by a shrinking workforce and aging population. The Nikkei dropped well below the 10,000 level several times along this difficult path.
Even following an impressive rally over the past year, the Nikkei remains significantly below its previous best. Moreover, accounting for the effects of inflation over the intervening years, Japan’s stock market is nowhere near as highly rated as it once was. Today, shares trade on an unspectacular multiple of around 25 times the earnings companies are expected to make this year, and at a small discount to their global peers2.
That rating falls far short of the multiples of around 40 times forward earnings Japan’s leading share index was trading on at the end of 1989, and less still than the 75 times ratio of prices to earnings seen after earnings collapsed in the early 1990s3.
It may be, however, that Japan is set to vanquish some old demons as it recovers from the Covid-19 pandemic – the last in a line of great challenges faced down by the country over the past three decades. Health ministry approval of the Pfizer-BioNTech vaccine came last weekend, and hopes are increasing that a post-pandemic world of pent-up consumer demand and stirring inflationary pressures will alleviate at least two of Japan’s historic bugbears.
As in the west, Japan has taken great steps to fight the pandemic, prop up the economy and protect jobs with cash handouts and subsidies, along with pledges to invest in new digital and green technologies. Three supplementary budgets were announced last year, estimated to be worth around 17% of Japan’s entire annual economic output4.
The early signs are the strategy is working. The economy is already much of the way back to pre-pandemic levels, bouncing back a better-than-expected 22.9% then 12.7% on an annualised basis in the third and fourth quarters of last year⁵.
Japan’s new prime minister, Yoshihide Suga, seems intent on pushing ahead with the programme of reforms begun under his predecessor, Shinzho Abe. Mr Suga was, after all, chief cabinet secretary to the Abe government. Government policies include raising Japan’s minimum wage, agricultural reforms and boosting tourism.
A deferred “Tokyo 2020” ought to assist with the latter, should it go ahead in July as planned, although a lack of foreign visitors is expected and bound to hurt. This week we learned the Games will be led by Seiko Hashimoto, Japan’s former Olympics Minister and a seven time Olympian herself.
If there is such a thing, the stars seem to be aligning for Japan. As investors worldwide turn their attentions towards economically sensitive, so-called “cyclical” shares, Japan is in a prime position to benefit. Its stock market is relatively cyclical, with a multiplicity of internationally recognised autos and electronics names as well as banks.
Some of the year’s big winners so far are familiar, “old Japan” type companies that comfortably pre-date the internet era, such as Nikon, Konica Minolta and Citizen Watch, along with the tyre maker Bridgestone and Uniqlo operator, Fast Retailing⁶. That makes sense as investors look forward to a post-Covid bounce, where shuttered parts of the economy get revived, both at home and abroad.
An easy way forward is not assured. Demographics remain a clear and present danger, with a shrinking pool of working age people. This has negative implications for domestic consumption trends going forward and, therefore, the economic growth potential of the country as a whole (domestic consumption accounts for about a half of the entire economy). Even so, and in contrast to the heady days of the late 1980s, present valuations may belie what could still be a rewarding year ahead.
Three Japanese funds, with differing styles, make it onto Fidelity’s Select 50 list. The Baillie Gifford Japanese Fund has what might be described as a traditional, actively managed portfolio with a bias towards large companies. It aims to deliver growth over the long term and draws upon the expertise of the largest team of Japan specialists outside Japan. Current large holdings include the conglomerate SoftBank; owner of the largest e-commerce platform in Japan, Rakuten; and the financial services group SBI Holdings.
The LF Lindsell Train Japanese Equity Fund places great store in a company’s durability and invests in businesses with a high and stable return on capital and a low capital intensity, i.e. where the amount needed to be spent on property, plant and equipment is relatively low. The Fund has a heavy exposure to consumer franchises. Current large holdings include the world’s largest video games company, Nintendo, the chemical and cosmetics company, Kao, and Astellas Pharma, the Japanese pharmaceuticals giant. This fund aims to outperform over the longer term by investing in good quality companies, but might be expected to lag behind at times when the stock market is rising strongly.
Finally, the Man GLG Japan CoreAlpha Fund has a markedly different approach again. It focuses on shares in companies that have been out of favour for some considerable time, but which have the potential to stage a turnaround. As such, this fund has what might be called a contrarian approach – seeking opportunities that have been overlooked by others. The Fund’s largest holdings currently include the banking giants Mitsubishi UFJ Financial and Sumitomo Mitsui Financial – and Honda.
Past performance is not a reliable indicator of future returns
Source: Refinitiv, total returns as at 31.01.21
1 - The Wall Street Journal, 29.12.14 and Federal Reserve Bank of St. Louis, 18.02.21
2 - MSCI, 31.01.21
3 - FT, 25.08.10
4 - FT, 08.12.20
5 - Cabinet Office, 15.02.21
6 - Bloomberg, 18.02.21
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Please be aware that past performance is not a reliable guide indicator of future returns. 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 or sell a fund. These funds invest in overseas markets and so the value of investments can be affected by changes in currency exchange rates. The value of investments and the income from them can go down as well as up, so you may get back less than you invest. 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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