Japan took a significant blow in the economic downturn, but experts say the country is already making a comeback, as Raquel Pichardo-Allison reports
Investors may have to look beyond the economic gloom to find opportunities in Japan. However, for those prepared to look there seem to be plenty of encouraging signs as Japanese equities managers and consultants are once again turning to the world’s second largest economy in search of returns.
Proponents are arguing that Japanese companies are coming out of the crisis leaner than their western counterparts, but remain heavily undervalued. New government policies are promoting domestic spending. In addition, Japan’s position in Asia as a provider of consumer goods to fast-growing countries like China, positions Japanese companies for growth going forward.
Now is a very good time to invest. The Japanese economy is lagging behind its global peers
Hewitt Associates global head of asset allocation in London Colin Robertson said: “It’s something we’ve been talking to our clients about a lot... Japan doesn’t have the aftermath of the crisis other countries have.”
He said the excesses that hit the west did not hit Japan, and much of Japan’s appeal has to do with the relative weakness of other developed countries.
“Japan is very much a relative story. It’s not so much that it’s in better shape now,” he said. Growth, “though uninspiring,” will be sufficiently strong to drive up the profits of Japanese companies, he added.
Signs of recovery
Japanese equity manager DIAM’s head of business development and client services Laura Palomino de Forbes agrees Japan’s growth prospects are developing.
“There is definitely a consumption and private expenditure theme that wasn’t there five, 10 years ago,” she said.
She added that she had seen searches for Japanese managers pick up since June.
“For institutional investors, it’s not necessarily a first time thing. Some have come out and are looking to get back in again. Others had maybe gone all passive and suffered, so now want to be more aggressive,” she said. Though de Forbes said flows from European and Middle Eastern investors into DIAM’s strategies have generally been steady over the past decade.
On the surface, the timing may seem off. In late October, the Bank of Japan, the country’s central bank, said the economy would likely remain in deflation mode for another two years. A Fitch Rating’s report on Japan released in early November said: “The global recession has had a profound impact on the Japanese economy, as the downturn in early 2009 was concentrated in the high value-added manufacturing sector, in which Japan has a comparative advantage. Fitch Ratings forecasts real (gross domestic product) will contract by 6.3% in 2009. The recovery is expected to be gradual, relatively weak and subject to setbacks.”
Nikko Asset Management Europe investment product director Yu Iwata said deflation has its benefits for Japanese companies. He said: “What deflation does, is force the company to focus on their competitiveness and have a strong balance sheet. This has forced (Japanese companies) to stay nimble and clean up their balance sheets.”
But the real driver repeated over and over by asset managers boils down to valuations: Japanese equities are cheap.
Iwata said: “If you have a medium to long-term time horizon, from a valuation standpoint (Japanese equities are) attractive.”
Nikko has seen US$1.7bn in new flows coming into its Japanese value equity strategy from European and Middle Eastern investors over the past three months. The strategy has $4.5bn in assets under management.
Equity performance
The Japanese equity markets have shown weak year to date performance, but have been positive in the past year. However, they have not surged the way markets in other Asian and western countries have.
Year to date to November 13, the Tokyo Stock Price Index, known as the TOPIX, was down 1%. By comparison, China’s Shanghai Composite Index and India’s SENSEX have been up 65% and 70% respectively in the same time period.
The US’s S&P500 was up 21.06% during year to date to November 13.
In the year ended November 13, the TOPIX was up 3.5%; the Shanghai Composite was up 70%; the SENSEX, 76% and the S&P500 17.45%.
Despite the outperformance of some of the other markets, The TOPIX’s positive performance over the past year has piqued the interest of some investors, managers said.
“I think that’s a situation which makes investors have some interest,” said Chuo Mitsui Asset Management, portfolio specialist Daisuka Ishihara.
Chuo Mitsui set up shop in London in February to promote its Japanese equity strategies and has seen a marked change in sentiment during that time.
Ishihara said: “When we started there was a very negative sense in the market about Japanese equities, but now it’s more positive. Consultants are starting to research Japanese equity managers.”
Tokio Marine Asset Management head of Japanese equities Tatsuhiko Takura said valuation levels are below those of 2003 when the country faced a banking crisis.
“Now is a very good time to invest. The Japanese economy is lagging behind its global peers. Given that Japan is part of a major economic region, this large difference is not justified,” he said. “One of the reasons why TOPIX has been so weak is a weakness in the banking sector. The banking industry is not a growing industry. Recovery is coming on the pricing side. Prices are distorted.”
There are two factors keeping prices down, he and others said.
Under Basel II, banks cannot count preferred shares as core capital as they could in the past. As a result, there could be a flood of ordinary share issuances eroding value as banks look to raise capital.
Basel II was initially published in 2004 and created an international standard for regulators to use when determining how much capital banks need to put aside.
Secondly, banks had moved to acquire consumer financial companies around 2004 during a time of loose interest rate regulations that allowed them to charge high interest. New financial regulations that came into effect in 2006 have since capped the level of interest these companies can charge.
“There is a possibility that the government may now ask consumer financial companies to refund the benefits they enjoyed in the past. There is some concern this will hit banks... and concern that the new government is hawkish on the banking sector,” said Takura. “We’ve looked into those issues and the current price of the banking sector. Every bad aspect has been priced in, and these are quite extreme outlooks,” he said.
Political changes
On the political stage, the Democratic Party of Japan took control in September ousting the Liberal Democratic Party that had ruled Japan since 1955. The DPJ’s relatively leftist views have raised both concerns and hopes about what this means for Japan’s economy.
Ishihara said: “There is a change in the bureaucratic leadership way. This worked really well in the 1950s, 1980s and 1990s but not in more recent years.”
Others said the new government’s commitment to increase consumer spending and encourage clean energy developments will boost the Japanese economies and companies.
“The policy of the new government is to give cash out to households for child care and low CO2 emissions. That’s a very unorthodox approach,” said DIAM’s de Forbes.
But spending from outside the country, particularly China, is helping Japanese companies grow with Nikko’s Iawata saying this leaves Japan “in a very good strategic position.”
Nomura Asset Management investment strategist Peter Jenkins agreed saying: “Japan is a supplier of capital goods to Asia. It’s in the right part of the woods”.
Japan is also benefiting from China’s launch of a CNY4trn (US$586bn) economic stimulus package.
Chuo Mitsui’s Ishihara said: “This country is spending a lot of money on its economic stimulus plan, and that is benefiting Japanese companies in two areas. Infrastructure – the Chinese are building railroad and electric plants.”
And, he said, Chinese tourists have been stocking up on the higher quality Japanese goods.
“Chinese tourists come to Japan and spend 10 times more than a Japanese person would at the airports,” he said.
However, despite Japan’s potential for growth, it still remains a hard sell for managers. Nikko’s Iwata pointed to the fact that Japan is “not as exciting as China and India... It doesn’t give you the ‘wow’ factor.”
Meanwhile Nomura’s Jenkins said that while the firm believes in the long-term growth prospects of Japan, timing an entry into the markets has been tricky.
“The timing has proved to be problematic in the past and could prove to be problematic in the future,” he said.
