In what has been a torrid period for global equity markets, the Japanese market has fallen sharply i...
In what has been a torrid period for global equity markets, the Japanese market has fallen sharply in recent months. Furthermore, the credit crisis has stepped up a gear, resulting in the failure or takeover of several high-profile financial institutions, both in the US and Europe. Overall, the effects of the turmoil in financial markets are spreading out from the US, affecting more of Japan's key export markets.
Given the high level of investor uncertainty, we remain cautious on the near-term outlook in anticipation of further market weakness and volatility.
However, on the positive side, we believe the Japanese economy is in better shape to resist a global recession than in previous cycles. Although the domestic economy is clearly slowing, we believe that the downturn is cyclical rather than structural and may be shallower than in most other developed markets.
The Japanese banking system is relatively immune from the credit crunch, with banks' balance sheets strong and exposure to write-downs limited. Also debt levels, both household and corporate, are relatively low, requiring less painful deleveraging than will be the case in other developed economies.
Although exports have weakened recently, we believe that there is longer-term support for Japanese exports once the global cycle troughs, given Japan's leading technologies and strong global brands.
Further support for the Japanese market comes from aggregate valuations, which are very low relative to history. We have seen previous occasions where more than 60% of stocks have traded on less than book value.
However, it is rare that we see such attractive valuations at a time when corporate returns are so high, and rising. Also, the dividend yield on the Japanese market now exceeds the Japanese government bond yield by some margin, which historically has preceded a market recovery.
In this environment, we continue selectively to add to stocks with significant upside potential, particularly those cyclicals with visible earnings which have been oversold.
As sentiment is likely to dominate share price performance for some time, we have also been increasing our exposure to companies that are generating strong and visible cashflows.
This serves to reduce our exposure to the risk of earnings disappointment, which is having a disproportionate effect on share price returns. In particular, we continue to have a relatively high exposure to defensive growth sectors such as pharmaceuticals and land transport, where we are finding stocks with upside potential.
Overall, we believe that investors with a focus on highly detailed stock-specific research are best positioned to turn the tough recent market conditions to their advantage. Market weakness is throwing up some attractive investment opportunities and those who are able to exploit these should deliver strong returns over the medium to longer term.
- By Andrew Rose, fund manager of the Schroder Tokyo Fund
- Further near-term volatility likely given investor uncertainty
- Japanese economy better placed to weather global recession than in the past
- Aggregate market valuations very low relative to history.
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