The Japanese market has been driven into relative outperformance by a growing stream of positive dom...
The Japanese market has been driven into relative outperformance by a growing stream of positive domestic news, says Denis Clough, head of Japanese equities at Schroders.
Crucial among these is that the weakening of the currency has given impetus to export-driven companies, which make up around a third of the entire stock market.
'Japan's equity market has significantly outperformed all other major markets this year despite persistent problems and the outlook remains positive for a number of reasons,' says Clough.
'Japan failed to participate fully in the global equity market bounce following 11 September. Domestic concerns about bank sector bad debts, downgrades by credit rating agencies and a falling yen have weighed heavily on investors' enthusiasm.
'Expectations for economic growth have become less bullish and some of Japan's outperformance is due to the narrowing of this valuation gap.'
On the positive factors driving the market, Clough says yen weakness catalysed an improvement in exports, a big positive for a market in which 30% of earnings are derived from overseas/export activity. 'The hope this would stimulate a mild cyclical recovery also boosted the prices of domestically-focused companies and statistics suggest this has started to happen,' he adds.
However, Clough believes that attributing Japan's relative recovery simply to a weak yen is to miss the restructuring story.
'There has been a strong undercurrent of structural improvement at an individual company level,' he says. 'Many of Japan's more progressive companies are completing three-year restructuring plans, which will generate a sharp rebound in reported earnings this year as restructuring costs fall out of the profit equation.
'In time, rising returns on equity should enhance the stock market impact of a modest return to economic growth.'
Concerns about growth, debt and accounting in the US have caused the yen to regain some strength and have weakened Japan's export position, says Clough.
However, he adds: 'Weak growth in the US may not be too damaging but a second bout of recession and falling Japanese exports could undermine the positive outlook. Most commentators predict the US will avoid a double dip, so the case for Japan remains positive.'
Charles Franklin, head of the Japanese equity team at Threadneedle, is less sanguine on Japan as the situation in the US becomes more difficult to assess. However, he concedes there is a recovery in Japan, which is likely to continue into next year, providing the Japanese markets are not dragged down by events in the US.
If the US remains stable, the Japanese government is likely to support the markets, says Franklin, which it has demonstrated by changing regulations to limit short selling. It can also use cashflow into government pension funds, which are managed by big trust banks in Japan, to provide further support.
Franklin agrees with Clough that the biggest factor in Japan's recovery has been demand from overseas. A drop in US demand has led him to favour domestic areas of the economy.
'We are becoming less confident as we have a more cautious view of the US,' he says.
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