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Japan: Land of the rising stock market

Anthony Fensom  |  29 Aug 2017Text size  Decrease  Increase  |  
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Asked which Asian nation has seen double-digit stock market gains and 4 per cent economic growth, few investors might guess the answer. But Japan, the world's third-biggest economy and until recently Asia's sleeping giant, has started to awaken and investors are taking notice.


On 28 August, Japan's Nikkei Stock Average closed at 19,449, showing a healthy 18 per cent gain over the past year, while the Tokyo stock exchange's Topix index was at 1,600, up 24.5 per cent, placing it among Asia's top performers.

In contrast, Australia's S&P/ASX 200 index was up over 10 per cent over the past year, while the All Ordinaries index was showing a 9.5 per cent one-year rise.

Japan's latest GDP data showed it has extended its longest economic expansion since 2006, with the June quarter's stronger-than-expected gain contributing to six straight quarterly rises. The 4 per cent GDP gain confounded economists' expectations for a 2.5 per cent rise, while nominal growth was an even stronger 4.6 per cent annualised increase.

The main driver was improved domestic demand, along with stronger business investment and government spending, even while exports slipped. Healthy consumer spending has followed the lowest jobless rate in 23 years, of just 2.8 per cent, while the job-to-applicant ratio has swollen to 1.51, its highest level since 1974.

"The April-June GDP report suggests that the Japanese economy has entered into a sweet spot, with growth accelerating and broadening into all components of domestic demand. While the 4 per cent annualised GDP growth rate marks peak slingshot acceleration, the details of the report fully verify our thesis that Japan has entered a self-sustaining domestic demand-led up-cycle," said WisdomTree Japan's Jesper Koll.

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Koll points to rising wages, an improved housing cycle, and the return of corporate "animal spirits" as contributing to the upturn in Asia's second-largest economy. Capital expenditure (capex) by businesses now nears 16 per cent of GDP, around a full percentage point higher than its long-term average, with the structural drivers seen contributing to a sustained upturn in business investment.

The Tokyo-based economist sees the Abe government continuing its expansionary fiscal policy, while the Bank of Japan (BoJ) is expected to maintain its ultra-easy policy until it reaches its inflation target. Improved economic performance of 2 to 2.5 per cent real GDP growth is tipped through to fiscal 2019, according to WisdomTree Japan.

Capital Economics' Marcel Thieliant, senior Japan economist, expects the Japanese economy to expand by 1.5 per cent in 2017, although he has projected it easing to just 1 per cent next year as external demand cools.

The projections compare to the International Monetary Fund's latest forecast, which predicted 1.3 per cent GDP growth in 2017, but just 0.6 per cent next year.

Earnings growth

Another economist to see value in Japan is BetaShares' David Bassanese, who in a 22 August report described Japanese equities as "relatively cheap by global standards".

As well as the improved GDP data, Bassanese points to stronger corporate earnings. Over the year to end-July, Japanese "forward" earnings grew by 17.6 per cent compared to US growth of 9.6 per cent, with the earnings of Nikkei 225 companies matching pace with their US counterparts over the past decade.

While Australian forward earnings saw a growth spurt over the past year due to higher iron ore prices, they have generally lagged both Japan and the United States since the 2011 peak in commodity prices.

Meanwhile, Japanese valuations remain relatively attractive, with the current price-to-forward earnings (forward PE) ratio in line with its long-run average of about 16.5. In contrast, the World MSCI index and the US S&P 500 are trading well above their long-term averages, according to Bassanese.

The Australian economist also pointed out that Japanese stocks "have tended to perform particularly well during periods of yen weakness". While a stronger yen this year has reduced exporters' earnings and dampened the outlook for Japanese exporters such as Canon and Toyota, a weaker currency is anticipated as the US Federal Reserve tightens policy over the coming year, in contrast to the BoJ's ultra-easy policy.

Sectoral opportunities

In a July 2017 report, Nikko Asset Management (Nikko AM) suggested government changes aimed at curbing excessive overtime and enhancing labour productivity would spur increased private investment.

Nikko AM pointed to a March 2017 survey by Japanese financial daily, Nikkei, that found 80 per cent of respondent companies were either planning or considering implementing productivity-enhancing investments. These range from increased use of flexi-time and telecommuting, to artificial intelligence and big data.

Along with the IT sector, Japan's services sector is another target, given its low productivity compared to the OECD average. In one example, Nikko AM refers to a convenience store chain that is expected to increase capex by over 40 per cent in fiscal 2017 to enhance productivity amid a tight labour market.

The construction sector is also seeking to take advantage of "labour saving capital" given the increasing demand related to the 2020 Tokyo Olympics but a declining supply of workers. The Japanese government is encouraging firms to invest in IT as part of its "i-Construction" standard that aims to raise productivity, boosting demand for materials, machines, and technology infrastructure.

"The common denominator is that Japan has a substantial need for automation which can be met by competitive and innovative companies. Addressing the challenges of low productivity in Japan will result in a wealth of product and process innovation that will eventually be exported overseas," the report says.

Naoki Kamiyama, Nikko AM's chief strategist, suggested Japanese robotics and system integration companies would benefit from the trend, along with financials, which should see improved profitability with the end of deflation.

The investment manager expects the Nikkei to reach 21,250 by March 2018, based on a 5 to 10 per cent rise in corporate earnings per share, with a 1,700 target for the Topix. It expects the yen to trade at around 115 to the US dollar by March 2018, based on a slow pace of rate hikes by the Fed.

For "Abenomics," which has comprised fiscal and monetary stimulus together with structural reform, Kamiyama said "the most important parts are already set ... we are just waiting on aggregate demand expansion to act as the final trigger to make these policies more effective," helped by the global recovery.

Investors seeking to capitalise on Japan's revival have a number of options, ranging from direct shares to exchange-traded and other funds. Among the latter are BetaShares WisdomTree Japan ETF--Currency Hedged (ASX: HJPN), with top exposures including Toyota Motor and Mitsubishi UFJ, and the Nikko AM Japan Share Concentrated Fund [41685], with top holdings including Nidec, Keyence and Sony. Others include iShares MSCI Japan ETF (ASX: IJP) and the Platinum Japan Fund [5345].

Australian interest in Japan is surging, as demonstrated by the record 358,500 Australian tourists who visited in 2016. For investors, exploring Japanese equities could prove rewarding too, as the land of the rising sun enjoys an extended period of economic sunshine.

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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