Japanese shares remain relatively inexpensive versus certain other major developed markets. Although the economy has been improving, foreign investors still "under-allocate" to Japan, the author of this article says.

The following article looks at the case for investing in Japan. At a time when Asia is caught up in the coronavirus saga, disrupting economic activity in the region and further afield, it might be wise to stand back and examine a specific country. Under the Shinzo Abe-led government in Japan, the country has instituted reforms including supply-side measures to make it easier to improve companies’ returns. Decades of sub-par growth have left investors disappointed with Japan, but maybe the country’s time has come. 

To explore these points is Joël Le Saux, portfolio manager of the OYSTER Japan Opportunities fund at the Swiss firm, SYZ Asset Management. The editors here are pleased to share these views; the usual editorial disclaimers of course apply. To comment, email tom.burroughes@wealthbriefing.com or jackie.bennion@clearviewpublishing.com

Following decades of deflationary despondency, the Japanese economy is springing back to life. Yet foreign investors continue to under-allocate, creating a discount to other developed markets. The Topix is trading at a price/earnings ratio in line with its seven-year average, and significantly beneath that of both the US and Europe. The question is: will this trend reverse in 2020?

Despite stubborn negative market sentiment, the underlying dynamics of the world’s fourth largest economy have created a fertile bed for equity investors. 

Below, I explain the reasons why Japan valuations have been suppressed and discuss why the archipelago offers investors compelling long-term value in 2020.

Tax hike fears overblown
The latest consumption tax hike was delayed due to fears that it would negatively impact consumption, before finally being implemented in October of 2019. However, the enactment was successful, with minimal impact on the economy, no changes in consumption patterns and, more importantly, no return into deflation.

This was partly due to preventative measures, which exempted food products from the tax, and partly due to the robustness of the economy, with jobless rates at multi-decade lows and wages rising.

The number of train users – the best measure for the health of the Japanese economy – is still increasing and GDP growth for Q3 surpassed expectations.

---

Savings culture lowers volatility 
Perhaps negative investor sentiment surrounding Japan can be explained by low consumer confidence numbers. At ten-year lows, the figures are a reminder of scars from the past. Due to decades of deflation, the Japanese have become staunch savers. While wages increased by 2 per cent per year over the past five years, consumption only rose by half, compromising the Bank of Japan’s intentions to spur inflation.

However, on the positive side, consistent low spending ensures minimal volatility for investors in periods of economic stagnation. Also compensating for the lack of consumption, the service sector has increased dramatically over the past two decades - now representing three times the manufacturing sector in terms of profit.

BoJ dialling back stimulus
Also known as the great market manipulator, the BoJ owns approximately 8 per cent of the Japanese stock market and has been consistently intervening in the bond market as part of its multi-trillion-yen stimulus programme. This has led some foreign investors to worry that the bank’s intervention is distorting liquidity and prices in the market.

Signs that the BoJ may now be poised to dial back stimulus have comforted foreign investors. Nevertheless, these investors must appreciate the bank’s assurance that it will intervene if markets drop, which provides an element of safety to investing in Japan.

Another unexpected buyer supported the market in 2019 – companies themselves, through buybacks. Share repurchase programmes increased, enhancing return on equity in spite of overall flat earnings growth.

Constructive earnings growth
The 2019 earnings season in Japan saw downward revisions in consensus earnings estimates for this year, with unchanged earnings versus 2018. However, earnings growth for this year remains constructive at 5 to 7 per cent.

Although this is considerably less than 2018’s 8 per cent, the market seems to have digested the lower earnings growth environment, which leaves less room for disappointment. Across the developed world, companies will find it hard to grow faster than GDP, and Japan will not be alone in this predicament.