There are reasons to be cautiously optimistic for the year ahead when investing in Japan, but the balance between caution and optimism could shift at any moment, according to experts.
While currency weakness can be a problem for importer countries such as the UK, a weak yen can be a boon for Japan. In fact, the Japanese yen has been even weaker than sterling this year against the US dollar (-23% against -15% of sterling to the beginning of November).
For the Japanese economy this is providing a tailwind to benefit its export-driven economy, with 17.5% of GDP coming from good sold overseas, explained Giles Worthington, senior fund manager of the Sanlam European Equity fund.
“With globally leading companies in many areas of machine and factory automation – Fanuc, Keyence and Hitachi to name only three, Japan has been able to leverage this currency advantage against its North American competition,” he said.
Performance of stock in the year to date
Source: Google Finance
But to what extent is that likely to continue, and what other trends are worth keeping track of?
Worthington said the global trend towards reshoring and the recent U-turn in China’s zero-Covid policy was an “opportune window for the economy”.
“An increased focus on investor returns means Japan is an attractive place for the global investor to find interesting ideas in 2023,” he said.
Shuntaro Takeuchi, manager of the Matthews Japan fund, agreed, especially as conditions worsen elsewhere in the world.
One sign of slowing down, according to the manager, is the global manufacturing purchasing managers index (PMI) indicating that multiple regions are heading into a recession.
“However, the Japanese economy could expect more stable growth over the next year, as relatively low inflation rates, continued monetary policy support, the reopening of the economy and supplemental fiscal budgets will support the domestic industry,” he said.
“Japan has lagged behind other markets in terms of post-Covid economic reopening, but the country did so in October. In our view, we are still in the early stages of recovery.”
Performance of fund since launch against sector and index
Source: FE Analytics
Andrew McCagg, senior client portfolio manager at Nomura Asset Management, also cited the resumption of domestic economic activities and the recovery in inbound tourism as chances to offset global slowdown concerns.
“Japanese equities look to be in a favourable position relative to other developed markets. Even exporters with larger exposures to global markets have been supported by the weak yen,” he said.
“As such, the earnings outlook in Japan remains robust, especially versus other markets, with recurring profits expected to grow by 11.2% in this financial year and by 5.5% in 2023.”
Like most markets, however, Japan will continue to be impacted by the Federal Reserve and other central banks, and by possible domestic monetary policy changes in March, when Haruhiko Kuroda, the current governor of the Bank of Japan, is set to step down.
“Expectations for the Bank of Japan to revisit its interest rate and yield curve control policies in spring of 2023 are growing. Considering the impact on both investor sentiment and the currency, such changes, along with a potential pivot by the Fed, will likely be key market drivers for the second year running,” concluded McCagg.
Among the enthusiasm, however, Dan Carter, co-manager of the Jupiter Japan Income fund, had a more nuanced view.
“Perhaps the market is always finely balanced, but as 2022 draws to a close it feels that the reasons for optimism and caution are in a particularly uneasy equilibrium,” he said.
“Optimists will focus upon the coming tourist-led bump in consumption, the boost to profits or competitiveness which comes with the weakness of the yen, and the prospect of an injection of economic vim as China ditched its ‘zero Covid’ policy.”
But the manager isn’t blind to the obstacles in the way of the market.
“Japan’s increasingly aged population acts as a brake on domestic spending and, even pre-pandemic, consumption growth was anaemic,” he said.
“Inflation, no longer a stranger in Japan, could also weigh on consumption. Compared to many other economies Japanese price rises remain muted – inflation hit 3% in September – but wages remain stubbornly low and with it the ability for higher consumer spending.”
Performance of fund over 10yrs against sector and index
Source: FE Analytics
Meanwhile, given the unpopularity of the yen, some analysts alluded to the possibility for Japan to reverse the multi-decade trend of outsourcing and begin reshoring manufacturing capacity.
“We’re not entirely sold on that narrative – Japan will never again be the ‘workshop of the world’ – but we do see how an environment in which companies are keen to reduce their reliance on Chinese manufacturing centres could play into the hands of Japan’s world-class capital goods companies,” said Carter.
According to the manager, one shouldn’t be encouraged too much by positive confidence surveys either, which remain “favourable” for large companies in both the Japanese manufacturing and service sectors.
“Perhaps paradoxically, this provides a problem for investors. Does the data suggest that economically cyclical companies are avoiding a demand catastrophe, or are they just about to walk into one?”
To answer this question, he looked at China.
“One major economic variable will be China. By dropping zero-Covid restrictions and resuming its economic activity, China’s recovery could coincide with, and at least partially offset, the dampening effects of higher interest rates elsewhere,” said Carter.
“Whilst our view is more nuanced than some, we still think that the scene is being set for attractive returns from the Japanese market throughout next year. These won’t come easily, though, so we are conscious of the need to be patient until that uneasy tension between the reasons to be optimistic and causes for concern has finally been resolved.”