The Nikkei delivered its highest annual return in 2013 since 2005 as the authorities looked to weaken the Yen and boost the market. However, despite huge amounts of bullish sentiment towards the region last year, the wheels have fallen off the rally and Japanese equities are down 6.59 per cent so far in 2014.
John Ventre (pictured), head of multi-manager at Old Mutual, says that while the signs looked promising last year, he has recently been selling down his exposure to the region as he expects there to be further pain to come.
“Japan is expensive,” he said. “The market is pricing in high shareholder returns but it is also trading a decent premium to book value.”
“I think a lot of people have been investing hope, but we think the rock will start to roll down the mountain eventually because real wage inflation is needed.”
“I do think there is the tendency for investors to say it is different this time in Japan.”
“However, that change in perception has stopped. The yen is no-longer weakening and equity markets have been broadly flat for the last few months. The fact that equities have been weak this year suggests the market had overshot itself.”
Performance of indices in 2014
Source: FE Analytics
Ventre says that the major reason for this year’s losses is because the market is waiting for signs that the “third arrow” of “abenomics” – structural reform – has been fired.
He says that the first two arrows, fiscal and monetary reform, were the easiest to implement and therefore it was no surprise to see the Nikkei rallying as a result. However, he doesn’t expect Prime Minister Abe’s structural reform to have the same effect on the market.
“Just about anything that is political will take a long time to materialise,” Ventre said.
“Central banks can do things quickly, but structural change takes a lot longer and it can take years before it is implemented. The nature of Japanese politics is also weighing on the third arrow and while we had owned Japanese equities last year, but we have since moved underweight.”
Due to the country’s lost decades of deflation, the Japanese equity market has been a perennial poor performer over the long term with the Nikkei returning just 41 per cent over 10 years compared to the FTSE All Share and S&P 500’s returns of more than 100 per cent.
Performance of indices over 10yrs
Source: FE Analytics
Toby Ricketts, manager of various fund of funds at Margetts, has also been selling his exposure to Japan as he says the outlook for the region is now dangerous as he questions what the benefits are of simply printing money.
“It is definitely different this time around for Japan, but I wouldn’t say it is any better,” Ricketts said.
“Whatever the outcome is of the great experiment that is QE, I can’t believe it won’t be without risks. We have seen the upside last year and people who timed it right have made a lot of money, but the easy money is now gone.”
“Those returns have since dropped off significantly. Will it create inflation? Almost certainly, but will it create an economic recovery? That is hard to say.”
“Japan, for me, is a big risk. While that could potentially mean big rewards, it is by no means a one way bet. You may well see some further upside, but that will be interspersed with quite significant sell-offs.”
Ricketts also says that if the ECB were to implement their own QE to stave off deflation, it could well create problems for Japanese exporters as European companies could once again become more profitable due to a weakened Euro.
There are a number of managers who are still positive on Japan, however.
Seven Investment Management’s Chris Darbyshire recently told FE Trustnet that investors would be wrong to sell their Japanese exposure following the recent slump and pointed to improving economic data, such as a pick-up in industrial production and the housing market, as reasons to be bullish on the region.
He also says it is the market, unlike the US and UK, where there are signs of earnings growth.
Paul Chesson, manager of the Invesco Perpetual Japan fund, says that the imminent tax rise and the need for wage inflation will put pressure on Japanese equities over the short term, but he isn’t overly concerned.
“While there may be some short term volatility, we retain our positive outlook on Japanese stocks. We believe the market is supported by low valuations, a weak currency, and expectations for further robust profit growth next fiscal year,” Chesson said.
“Given that the Topix index currently trades with a P/E ratio of 13 times earnings forecasted for the year to March 2015, we believe the risks are largely already in the price.” Rob Gleeson (pictured), head of FE Research, says that investors in Japan could see a huge return if the government and the Bank of Japan’s plans to kick start the economy pay-off. However, he says investors shouldn’t get carried away.
“The policy is quite high risk, but if it doesn’t work it is basically all over for Japan,” Gleeson said. “If they can reflate the economy and inflate their debt mountain away to something close to normal, then that will be good news. However, that is just a short term fix.”
“Its poor demographics, ageing population and mountain of debt mean that even the best case scenario for Japan is that it, economically, moves from terrible to bad. The long term outlook is not good.”
