Like many other of its equity counterparts, Japanese equities were caught in the tides of trade war tensions and earlier concerns over US inflation. We wrote on the
outlook for 2018 last year and highlighted that Japan is the dark horse to look at this year. Abe’s loose policy mix, strong growth anchor on current global economic recovery and robust external demand were all key catalysts.
Market participants seemed to share our view, buoying Japan equities to one of their best starts into 2018. However, it looks like the trend has fallen-off as markets turned. The Nikkei 225 is down -3.6% year-to-date, together with Japanese equity funds on our platform which posted an average loss of -1.9%. Given that, is the positive case for Japan still intact? In this article, we look to share some insights on the developments of Japan’s economy over 1Q2018.
FIGURE 1: Japanese equities and funds' YTD performances.
Nikkei 225: Nikkei 225 Index
MSCI Japan SC: MSCI Japan Small Cap Index
Affin Hwang World Series - Japan Growth Fund
Eastspring Investments Japan Dynamic Fund (MYR-Hedged)
RHB Entrepreneur Fund
United Japan Discovery Fund
Shunto to underscore domestic spending
The word “Shunto” refers to the annual wage negotiations between enterprise unions and the employers. Since Japan has been struggling with recession and deflation on top of falling union membership, the automatic wage increases associated with the initiative came under threat until Abe’s administration came in power.
The Shunto results that started in March shows that big Japanese companies have agreed to raise wages for a fifth successive year. Although most of the companies fell short of government’s targeted 3% hike, the outcome should still help drive up domestic consumption.
BoJ keeps lose
BoJ Chief Haruhiko Kuroda pledged on Monday to continue pursuing monetary stimulus in close coordination with Prime Minister Shinzo Abe, in order to achieve 2% targeted inflation. We do not foresee BoJ to withdraw stimulus at least for the remaining of 2018. Subsequently, this should keep JGB yields suppressed for the time being, which will help keep some downward pressure on the yen.
FIGURE 2: Yen's strength against Nikkei 225 Index.
Abenomics to continue
Recent headlines concerning Japan are revolving around Prime Minister Abe’s scandal, which is hurting his approval ratings on the domestic front. Market participants are interpreting this issue cautiously as this may affect the career longevity and economic policies that is run by his government, thereby contributing part of the volatility in Japanese equities.
Taking a look back at the snap election held last year, despite the scandals and political noises, Abe scored major victory in the national election and emerged as the longest serving leader in Japan. This portrays the confidence that the Japanese people have towards Abe and his policies. Looking at where we are today, the victory leaves Abe with most of the risk residing within his internal party, Liberal Democratic Party (LDP). However, there is no one within LDP stepping up to threaten Abe’s position as of now.
With the above, we see little threat towards the continuity of Abenomics. That essentially means that Japan is still trekking towards better economic equilibrium and higher corporate profitability.
FIGURE 3: Nominal growth surpassing long-term yields.
Structural reforms and increased fiscal spending
The continuation of Abe’s ruling also translates to still-loose fiscal policies and more structural reforms ahead. The primary objective of the government is to defeat inflation and increase labour force’ productivity by 2020. Post-election victory last year the government has already announced programs designed to enhance social security and education, along with increase budget on infrastructure spending.
Looking ahead, there is also a possible tailwind for investment activities amid preparation for 2020 Olympics in Tokyo, serving as a potential leg-up to Japan’s GDP growth.
To sum it up, Japanese equities still look attractive to us. We believe the positive elements mentioned above are constructive for Japan’s economic growth and corporate earnings. There is still a reasonable headroom for Japanese equities to trend higher, given their current progress towards reflation and continued profit growth. Also, domestic demand and spending have started to gain traction.
Valuation wise, PE ratios are sitting at 15.7X and 13.9X for FY2018 and FY2019 respectively (as of 11 April 2018) against our fair PE value for the Japanese market is 18.0X.
Against the current backdrop where geopolitical tensions escalate and trade war worries linger, the road ahead is unlikely a smooth one. We advocate investors to be mindful of the supplementary exposures that they are taking on. We recommend investors to allocate not more than 20% of their equity budget to supplementary exposure.