Although the domestic economy has come out of recession, the pace of Japanese recovery remains slo...
Although the domestic economy has come out of recession, the pace of Japanese recovery remains slow. While the Bank of Japan's recent decision to cut interest rates to zero again was a sensible move, it will not solve the country's problems on its own.
The really positive developments are taking place at the corporate level. Many companies have restructured and cut their costs, and there is evidence that Japanese managers are focusing more on their shareholders. However, the need to restructure is challenging Japan's culture of a 'job for life'. So, although the trend will bring long-term benefits, it has dented consumer confidence and made people cautious about spending in the shops.
The surest way to boost investment performance over the past year has been to avoid most of the new economy shares. We have had little or no exposure to companies such as NTT DoCoMo and Softbank. This was not because we thought the prospects for these companies were particularly poor, but because early last year, their share prices implied a level of long-term growth in profits that was not credible.
We have also held a relatively low exposure to banks. While there has been reform across the sector in the last few years, many banks are still weighed down with deep-rooted problems. Many banks still have a large number of non-performing loans on their balance sheets.
There are better opportunities elsewhere to invest in companies at more reasonable prices, but which offer a reliable stream of future profits. Railway companies for example have been cutting costs, which has resulted in higher profits despite a difficult economic backdrop.
Selected pharmaceuticals companies are doubly attractive because their business is relatively unaffected by the country's short-term economic problems, but they also belong to a sector with strong, long-term growth. Many of Japan's pharmaceuticals companies are becoming increasingly global and are growing their overseas sales. A lot of progress has been made on harmonising rules governing clinical trials. Drugs can now be developed in Japan and the results from clinical trials there can be used to licence the drug in another country.
While the near-term outlook may be for more stock market volatility, history shows us that share prices can rally if cuts in interest rates allow investors to focus on better prospects ahead. With interest rates falling in major economies such as the US, we believe we are heading for a turning point in equity markets.
We think the bad news is already discounted in share prices, which stand at attractive valuations compared to markets such as the US. We believe that this, coupled with growing profits among those companies that have cut their costs, will lead to strong returns from the Japanese market for the long-term investor.
Denis Clough is manager of the Schroder Tokyo Fund
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