By Steven Wheeler, head of Japanese equities at Rothschild Asset Management Since the start of 2...
By Steven Wheeler, head of Japanese equities at Rothschild Asset Management
Since the start of 2002, leading economic indicators in Japan have enjoyed a rapid rebound. But the improving tone in the Japanese economy has been driven almost entirely by the strengthening global economy.
The domestic economy shows few signs of having any momentum independent of external demand. However, the peaking of the OECD's leading indicator and renewed concerns over the technology cycle mean we are likely to see a pause in the recovery of Japanese indicators over the next few months, and probably some retracement. Such a scenario is likely to be negative for market sentiment.
Another factor weighing on the market is the lack of any tangible progress on policy, especially relating to the financial system. An increasingly fudged approach to the issue of deposit insurance highlights the gridlock in this area.
As far as the market is concerned, there is not much of a following wind either from economic momentum or new policy initiatives.
Unfortunately, sentiment is unlikely to derive a great deal of support from the corporate earnings backdrop either. First, although profits are likely to recover sharply in the current year, helped in part by cost cutting, they are coming off a very low base and are distorted by the impact of heavy one-off charges last year.
Second, company forecasts at the start of the year were too optimistic and are now starting to be revised down. While the first half of the fiscal year was quite positive for companies, and in the second half, year-on-year figures will be helped by base effects, profit momentum in absolute terms is probably peaking now. The strengthening of the yen to levels higher than those initially assumed by companies will also be a drag in the second half of the year.
Nevertheless, even if profits undershoot company forecasts to some degree, valuations are not stretched. The Japanese market as a whole looks quite cheap on a variety of criteria relative to its non-bubble historic levels.
In addition, the Topix index is close to the low established early in the year, when rumours of financial crisis abounded. Given this valuation and technical support, we expect a moderate rebound in the short term.
However, the size of this rebound is likely to be limited both by the economic concerns described above and sales of cross shareholdings before the closing of books for the interim period.
We are maintaining a fairly even sector balance in our portfolios, albeit with a somewhat defensive and domestic tilt, recently adding to our holding in Tokyo Gas, which has adopted a pragmatic and shareholder-friendly approach to its business.
Several Japanese pharmaceutical companies, such as Chugai and Eisai, that combine healthy profit growth with attractive valuations have been identified. We have a long-standing underweight position in banks and, considering cyclical trends, we are underweight certain basic cyclical areas.
In the exporting sectors, we are focusing on quality companies where recent selling has reduced the customary premium valuations. In particular, we favour autos such as Toyota.
Valuations are not stretched.
Market close to bottom of its trading range.
Sell-off has thrown up stock opportunities.
Domestic economy remains weak.
Question marks over global economy.
Corporate profits should turn down.
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