We are still optimistic about Japan, but why? We are optimistic because, in our view, the two majo...
We are still optimistic about Japan, but why?
We are optimistic because, in our view, the two major drivers of growth in the world, the US consumer and China, will continue to grow (albeit at a slower rate) and this positive external environment will help Japan. The longer Japan has to resolve its (dwindling) bad debts and rehabilitate ailing corporations, and the longer it has to rebuild profits and domestic demand, then the more confident we are that Japan has truly bottomed out. We expect another year of progress.
What progress has been made?
We have seen dramatic progress in terms of individual Japanese companies restructuring and we are now seeing companies shift to a growth approach. Companies are cautiously expanding capacity and replacing obsolete technology (strong machinery orders were reported in December), while companies are hiring again and wages and bonuses are rising, although not by much. Finally, after several years, inflationary expectations are moving up. The latest Bank of Japan (BoJ) survey displayed a rise in expectations for inflation over the next 12 months from 1.4% in September to 1.8% currently. Real estate pricing is also stabilising and consumer sentiment surveys are holding steady, while employment indexes are improving. Against this backdrop, we feel that the Japanese economy should produce another year of growth driven by exports but with a greater contribution from the domestic economy.
More concretely, we should see two significant developments. The first is loan growth from the banking sector (leading regional banks have already been positive for three months in a row) and secondly, several months of positive CPI data. These two factors should refocus attention on Japan and especially on its attractive valuations compared to the US market.
Where are we investing?
Our belief that Japan is steadily restructuring means that we are focusing on companies that are restructuring or that benefit from change. For example, we have been adding to selected food stocks which are benefiting from the rise of powerful convenience store chains and selling pre-packaged food to Japanese consumers. We have increased our property exposure both in terms of mass-market developers and shopping mall developers, who are able to pick up sites from restructuring industrial groups. We have also been adding to some retail stores as we expect an end to the deflationary environment and stronger consumer spending. The currently tough environment is taking its toll and the opportunities for M&A are increasing - offering the chance to make big improvements to a company's strategic positioning. We expect that these strong companies will continue to clearly pull away from their rivals.
The fund has also maintained an exposure to commodities such as steel, copper and LNG where we expect Chinese and Indian demand for raw materials to continue to drive prices and where stock valuations are very low. Selected software and technology companies are also worth holding, particularly niche players where we expect rising product penetration into a large market, such as camera lens modules for mobile phone handsets. In TVs, we are steering away from LCD and focusing instead on Rear Projection TVs, which we feel offer consumers better value. We have also taken some exposure to the changing market in Japanese telecoms, where the rise of Voice-over-Internet Protocol and deregulation has allowed new entrants such as Softbank to aggressively attack the incumbent operators with their much cheaper 'Otoku Line' offerings. The competition between carriers for customers should be intense so we expect their marketing and customer acquisition spending to rise strongly and help telemarketing companies to grow strongly.
Japan should remain in focus
We feel that Japan is at the beginning of a multi-year restructuring, with returns on assets and equity rising, and structural changes slowly coming through. The initial drivers have been and will remain external - Chinese consumption of goods and commodities, US demand for cars and consumer electronics. This benign external environment will encourage a pick-up in Japanese domestic optimism and demand, which combined with attractive valuations and the opportunity for ongoing industrial realignment, makes us bullish on Japanese stocks.
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