The Japanese stock market has made a solid start to the year. Economic data has been mixed but going...
The Japanese stock market has made a solid start to the year. Economic data has been mixed but going forward we are expecting some rebound following the soft patch encountered during the second half of last year. Nevertheless, the main reasons for confidence are still more at the company, rather than the macro-economic level, as the overall rate of growth in the economy is likely to be fairly modest.
The main impetus for share price appreciation in Japan will come from the efforts of well-managed companies to boost profits by reducing costs and improving returns to shareholders - it is among these companies that we believe the best investment opportunities are to be found.
The belief that the economy is likely to rebound from the weakness that characterised the second half of last year and that deflationary pressures are continuing slowly to abate, have helped the Japanese equity market make good, if unspectacular progress so far this year. Overseas investors have continued to play the lead role in terms of buying and have been encouraged by signs of active developments on the M&A front, some of it hostile, which is unusual.
Developments at the micro or company level continue to provide more underpinning to our confidence in the outlook for Japanese equities. Company profits are continuing to grow and we believe this trend will continue into this year and next, notwithstanding the negative impact of rising raw material costs. On this basis, valuations look reasonable compared with Japan's history and in an international context.
Against this background, we believe that the best investment potential can be found among attractively valued, cash generative companies that are capable of boosting profits growth via cost reductions and returning more of these benefits to shareholders. Although the underperformance of these 'good quality' companies that was seen in 2003 ended last year, they have not yet begun to outperform - there is still some way to go in terms of a bounce back in these stocks.
One area of the market where these kinds of companies can be found is land transportation, for example, East Japan Railway, which operates mainly in the Tokyo area. The company has relatively high earnings visibility and the management team is committed to cost reduction. Good investment potential is also available among trading companies as they are benefiting from strong commodity prices. Stocks such as Mitsui & Co are likely to gain due to the positive outlook for iron ore pricing and generally positive newsflow.
There are also several attractive opportunities among electrical appliance stocks. Ricoh is one of the world's major copier manufacturers, and we believe that the shares are undervalued given the solidity of the company's core business. We are also expecting a relatively rapid recovery in earnings in the near term, in the absence of one-off expenses that have depressed recent earnings figures.
The banking sector has recovered from the non-performing loan problems which have afflicted this area of the market for much of the last decade. However, in the absence of rising interest rates or stronger loan demand, the short-term profits outlook for the basic banking business is not that exciting and against this background valuations not yet that compelling.
Turning to the broader equity market backdrop, there has recently been an increased amount of domestic news concerning aggressive takeovers and defensive mergers, with investors becoming more focused on the delivery of shareholder returns and improvements in capital management. A related development is that in 2006, a new law permitting foreign companies to buy Japanese companies using paper (shares) rather than cash is likely to come into effect. As a result, a significant number of Japanese company managers are concerned about the increased possibility of takeover by foreign firms, which bodes well for the advancement of shareholders' interests.
Overall, the market fundamentals for Japan are encouraging. We believe that in a low-growth environment, the trend of restructuring and rationalisation can drive steady corporate profits growth over the next two years, while forecast valuations are also reasonable. A number of other developments at the corporate level, such as increasing pressure on management teams to raise shareholder returns, give us further confidence in the investment potential in the Japanese equity market.
Regular reminders and updates
9 December 2019 deadline
Joe McDonnell joins as head of portfolio solutions (EMEA)
Adviser of the Year - South East
Fidelity Multi Asset CIO's outlook