Are Japanese equities a good bet?

Four years since the launch of ‘Abenomics’, Japanese equities are performing well

Are Japanese equities a good bet?
As more Canadian investors realize the importance of exploring investment opportunities outside of the relative safety and comfort of the North American markets, advisors are being forced to present options from far and wide. Japan is one distant market that should be on advisor’s radars.

Four years launch since the launch of Prime Minister Shinzo Abe's ‘Abenomics’, a blend of fiscal and monetary policies and structural reforms, Japan’s economy and equities markets are performing well and look an attractive option for investors seeking some international exposure.

 “If we look at the trend since the launch of Abenomics, there has been a large jump in equities,” says David Latto, a portfolio manager at Unigestion. “The Nikkei 225 index was hovering around the 9,000 mark before Abe was elected, and it’s now past the 20,000 mark.”

The Abe administration has also placed much emphasis on restructuring and rejuvenating the labour market. Unemployment in Japan is now at a 22 year low and corporate earnings have rebounded.

“The government has implemented supply side reforms in an attempt to get more women into labour markets and to relax Japan’s very stringent labour market laws,” Latto says. “Those moves created a huge expectation of higher dividends, and we saw people like Dan Loeb asking for higher dividends on the back of higher profits. That was the backdrop of Abenomics; the different arrows. It’s been positive in terms of equity performance but structural reforms may take a little more time.”

With the Tokyo Olympics coming up in 2020, there has been a lot of interest in the construction sector and the TOPIX construction sub-index has performed well. Japan’s financial sector has also performed well, particularly since the election of Donald Trump.

“A lot of the performance is tied to FX, with a lot of the initial drive in equities being in sectors linked to the weakening yen, like large cap exporters,” Latto says. “The next wave was more toward small and medium firms as the FX stabilized after the crisis in March 2011 when the yen was around 75 – 80 against the U.S. dollar. It’s since recovered and is hovering around the 110 mark; its long-term average.”

Despite the positive indicators, risks that could impact Japan’s economic progress and equity markets remain on the horizon. Just yesterday, Prime Minister Abe Cabinet reshuffled his cabinet in an attempt to protect the ruling Liberal Democratic Party's falling approval ratings. Abe’s party recently lost heavily in the Tokyo elections following a scandal involving his wife’s connections to a kindergarten.

“There is a question mark over his sustainability, which wasn’t there a year ago when it was a foregone conclusion he would be in power until 2020,” Latto says. “Looking forward, there is also risk of trade friction especially with the U.S. and China, who is a big buyer of Japanese parts. That could lead to impacts for exporting firms.”

One major positives that cannot be overlooked is the fact that the Bank of Japan and the Government Pension Investment Fund (GPIF) are also investing in Japanese equities. Large private sector pension funds are also mimicking the trend. “Japanese equities tend to have higher volatility than European or U.S. names,” Latto says. “But when the central bank and the GPIF - the largest pension fund in the world – are investing it provides a certain protection against a large correction, even if they are tending to buy defensive stocks.”

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