Becket: Don’t give up on last year’s best performing funds

Regular readers of our blog will know that I am a deeply sceptical man.

Maybe this overarching scepticism is linked to my own personal self-criticism (a client recently described it nicely as “self-berating”), but I don’t know. Whether it is healthy or not is also unproven, but I don’t trust a word that either politicians or central bankers utter; it is far too often self-serving, self-promoting and without the best intentions of their citizens at heart.

Reading through the many articles and research papers claiming the failure of Abenomics in Japan has caused me to question (and beat myself up) of late whether the faith I uncharacteristically put in Abe-san and Kuroda-san, the respective Prime Minister of Japan and Bank of Japan Governor, was misplaced.

Despite having had to learn that humility and the ability to admit one’s mistakes are the most important characteristics for an investor to have, I hate admitting I was wrong (another obvious character flaw in the complicated patchwork).

So after the heavy falls in Japanese markets this year and the flood of money coming out of the region, I have spent a large amount of my time recently questioning my faith in our Japanese equity overweight and, having been a very passionate and early advocate of Japan’s market renaissance, asking whether I was “losing my religion” with Japan.

Performance of indices since January 2013

Source: FE Analytics

In a year when the investment gods have mostly been kind to our investment philosophy and positioning, the call to remain overweight Japanese equities after three excellent years has been painful.

Admittedly, the blow has been softened to a great extent by the strength of the yen and some good active manager selections, but I am still disappointed.

Performance of indices in 2016

Source: FE Analytics

The wider investment community, who had become extremely optimistic on the Japanese market, have been fleeing in their droves, hammering Japanese stocks and sending the yen higher, as they unwind their common FX hedges.

These moves have strengthened the resolve of the Japan ‘bears’, who claim that Japan remains a basket case and the only change in the country has been currency devaluation by the Bank of Japan, which temporarily inflated corporate profits.

Now this has “ended” they expect the Japan balloon to deflate.

Of course, the Bears are welcome to their view and I have always said within my bullish Japanese equity expectations that this is Japan; the chances are that the actions will work, but this will mean that ultimately over-confidence will bring about the next Japanese downfall. We are not there yet.

So what is going on to explain the extraordinary swing from loved to loathed and the recent collapse in Japanese equity valuations?

Firstly, I feel that, for all their good intentions, Abe-san and Kuroda-san have made mistakes; the former must refocus on his “mission” to restore pride in Japan’s economy and postpone the forthcoming consumption tax hike (April ’17), while the latter needs to offset the grave effects of negative interests in Japan’s financial system.

It might well be that Kuroda-san has a plan, but I see no method to the madness of negative interest rates. My expectation is that the Bank of Japan will move to offset the recent negativity in the market with fresh policies at their next meeting (28th April).

This could also include a massive increase to their equity purchases. Regular readers will also know that I often beg for silence from politicians and central bankers, alike.

My strong view is that if they just shut up for a while and allowed economies and markets stand on their own feet; in that perfect world we would have less volatility and be able to properly value investments once again.

Indeed, in the case of Japan, the hyperactivity and hyperbole actually detracts from the investment opportunity that is taking place at a stock level. We remain mightily impressed by the growing examples of improvement in corporate governance, which is being rewarded through rising share prices of those companies.

This is the main course in the Japanese market and deserves much more attention than what the authorities are doing.

It is also worth noting in a slow growing world, where we have real reservations about future growth in global corporate earnings, Japan’s profits growth rate stands out as admirable. Indeed, this year I would expect basically no profits growth at a headline level in the US, Europe or the UK (the latter skewed potentially by resources prices), while Japan is set to enjoy double-digits percentage growth. After recent falls in Japanese stocks, you could now buy the market on about 12 times earnings versus 16-17x times in Europe and the US.

So am I worried about the fact that everyone else is now worried about Japan? In short, no.

I am much more optimistic. The biggest fear we held for Japan at the end of the year was the confidence that others had in the investment case. As well as deep scepticism and a penchant for self-flagellation, you can add the fact that I am much more comfortable being a loner than in a crowd and this was the case with Japan.

That Japan has swung from consensus to once again contrarian in a few painful weeks fills me with pleasure and excitement for the future.

To put into simple context, you can buy a great story in Japanese equities, with attractive growth rates at cheap valuations.

Few people believe it and the hot money has been blown away with by the winter winds. Great themes including corporate self-help, the consumerization of China and inbound tourism should allow for good profits growth from certain companies in the coming years.

So it is not a case of “losing my religion” with Japan, but rather recognising that instead of worshipping Abe-san and Kuroda-san, I am paying homage at the altar of corporations, where we feel they are unfairly not getting the respect they deserve.