By Paul Chesson, manager of the Invesco Perpetual Japan Fund The Japanese stock market has perfo...
By Paul Chesson, manager of the Invesco Perpetual Japan Fund
The Japanese stock market has performed relatively well over the past year. In US dollar terms, the MSCI World Index fell by 18% in the year ending 31 July, while the MSCI Japan Index rose by 1%.
Given current concerns about the sustainability of growth in the US, it is perhaps surprising that Japan's stock market has shown so much resilience.
Historically, Japan has depended quite heavily on the US as a home for its exports. There are however good reasons for the market's relative success.
The first of these is that the Japanese economy has begun to recover only recently, meaning that the momentum of recovery is high. Japanese industrial production increased by 3.6% in the April-June quarter while GDP expanded by 5.7% (Jan-March).
Another reason for optimism is that Japan's corporate sector did not experience the levels of excess investment enjoyed by companies in other countries during the technology, media and telecoms bubble of the late 1990s.
At that time, Japanese companies were wrestling with a prolonged recession and investors showed themselves reluctant to provide funding under such conditions.
Finally, it is worth noting that the relative unpopularity of the Japanese stock market in recent years has meant equity valuations have slipped quietly lower. Today, shares are inexpensive by international standards, with P/Es (even on depressed earnings) and price-to-book values modest by comparison with those prevailing in the US.
Despite our relatively positive assessment of Japanese stock market prospects, we continue to invest very selectively. We are underweight blue-chip exporters, which, in our opinion, are overpriced and overly exposed to US economic fortunes.
One area of focus for us has been consumer staple companies trading on low valuations whose earnings should rise as a result of restructuring or other industry changes.
Of course, there remain significant risks to investing in Japan. The Japanese economy is highly dependent upon stock market levels, primarily because financial institutions are.
Some of Japan's major banks are probably technically insolvent already, and further worldwide stock market declines could engender a financial crisis.
At the same time, and despite a recovery in the manufacturing sector, pricing power on the high street is still weak, with consumer prices falling for the thirty-fourth month in succession in June.
Absolute stock market returns from here depend in part on the progress of the US economy. In the event that the US avoids a double-dip recession/slowdown, we would expect to see Japan's exports rising quite steadily over the next 12 months with positive consequences for equities. If the US does succumb to recession, we would expect the Japanese stock market to produce at least a good relative performance.
Deteriorating conditions in the US would probably be accompanied by a further fall in the value of the dollar and consequent rise in the yen, adding to the relative attractions of Japanese assets. In such circumstances, reasonable stock valuations should help to persuade investors to increase their exposure to Japanese equities.
Economic recovery underway.
Stock market no longer expensive.
Restructuring boosting profits.
US economic uncertainty.
Deflation set to continue.
Blue chip exporters expensive.
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