With a lockdown-free 2020 at an end, a new prime minister pledging more Abenomics and a vote of confidence from the world’s best-known investor, bullishness about the Japanese economy is growing, writes Tanya Ashreena.
When Warren Buffett announced that his investment firm Berkshire Hathaway had been building 5% stakes in Japan’s five trading houses, including Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo in the past year, many investors were surprised.
Just a few days before the Sage of Omaha’s pronouncement in September, Shinzo Abe, Japan’s premier, revealed he was going to resign due to ill health, and markets anticipated a pullback from foreign investors.
However, when Abe’s successor as prime minister, Yoshihide Suga, promised a continuation of his ‘Abenomics’ policies, markets were reassured and fund managers bullish.
“I am optimistic about Japan for several reasons,” says John Vail, chief global strategist at Nikko Asset Management. “It is an underappreciated market, and foreign investors aren’t overweight.”
Vail says Japan is a cyclical market that benefits from an upswing in the global economy more than other countries. “Japan’s stock market has a large number of cyclical stocks and value is starting to be recognised here, starting with Warren Buffett,” he says. “The trend now globally is to buy value stocks and Japan has a lot of them trading at a very inexpensive price-to -book basis, particularly in the banking and the trading companies sector.”
‘Extraordinary levels of stimulus’
The Japanese central bank’s aggressive response to the pandemic and commitment to maintain extraordinary levels of stimulus while not being as badly hit by the coronavirus leads to a supportive backdrop for equities, says Derek Halpenny, head of research at Mitsubishi UFJ Financial Group (MUFJ).
“There was a notable pick-up in ETF and corporate bond and Japanese government bond purchases by the Bank of Japan (BoJ),” he says.
As Japan is still the second-best-performing market of the major developed countries, and the outperformance is down to its policy of aggressive fiscal stimulus and reform-led GDP growth, the key question now is what actions Suga will take.
“While Suga has been talking of continuing Abenomics and reform-led growth, investors understand that the BoJ and its fiscal capacity are somewhat limited now because of the aggressive policies that have already taken place under Abenomics,” Halpenny explains.
“Our view is it’s going to be difficult, but the BoJ is going to maintain the extraordinary monetary stimulus.” he adds. “The BoJ needs to be an active buyer of Japanese government bonds in correlation to a strong fiscal stimulus and as long as a strong relationship continues, I think the macro backdrop will remain favourable.”
Vaccine to buoy stocks
Unlike Europe and the US, Japan is one of the few countries to have controlled the coronavirus fairly well. With a lower number of infections, it has not had to implement lockdowns to prevent the spread of Covid-19. As a result, the impact of the virus on the economy seems modest compared to that of other developed nations.
Nevertheless, Nikko Asset Management’s Vail expects the news of vaccines next year to lift Japanese stocks more than other markets. “In 2021, there will be vaccines that will relieve most of the worries about this pandemic, and the magnitude of improvement will be much higher in Japan than elsewhere because Japanese individuals and companies tend to be fairly cautious about the future,” he says.
“Also, Japanese companies have quite high operational gearing and their profit margins are a lot lower on average, so the benefits to the bottom line are much stronger than elsewhere, because low profit margins allow for a magnified increase in net profit from an equivalent amount of increase in net revenue.”
Vail’s stock picks include the Japanese automobile sector, as car sales hold up globally, and the banking sector, which is inexpensive at 4% yields. He is also optimistic about technology stocks, for companies that produce semiconductors and silicon wafers, and stocks involved in the digital transformation in the economy.
In his first 24 hours as prime minister, Suga created a new post by appointing Takuya Hirai as minister for digital transformation and established an agency to digitise bureaucracy, signalling how important the digital shift is to Japan. He also announced recently that a stimulus package on recovery would focus on digital innovation and green investment.
This did not come as a surprise. At the pandemic’s height, Japan had suffered delays in delivering cash handouts to its population. Online applications frequently faced glitches and would be scrapped in favour of paperwork.
Unlike other developed countries, only 8% of Japan’s transactions are cashless and the country continues the use of hanko seals, or personalised stamps the government requires for paperwork. An official review will attempt to cut their use from 14,992 procedures down to 83.
“The digital economy in Japan has a long way to go, particularly in cashless transactions, so stocks such as Softbank’s PayPay are expected to do well,” Vail says.
Katsunori Ogawa, chief portfolio manager of the Japan Sakigake strategy at Sumitomo Mitsui Trust Group (SuMi Trust), says companies in the areas of remote working, cashless payments and remote health services are already showing promising signs of innovation and improving financial returns.
“Suga’s digitalisation of the public sector will be a tailwind for companies providing online education and IT infrastructure,” he says.
The China effect
Japan is expected to benefit from the economic recovery in China, its largest trading partner, which has seen its economy growing despite the pandemic.
“In particular, automobile and consumer stocks, such as those in household goods, cosmetics and baby products, will benefit from the recovery in consumer confidence in China,” Ogawa says. Companies in the factory automation space will also gain ground, he adds, as the country seeks to cut rising labour costs.
However, at the same time, diplomatic tension between the US and China may also pose a risk.
“I wonder what implications Joe Biden’s relations with China would have in the region for Japan in terms of tariffs and disruptions to trade,” says MUFJ’s Halpenny.
“Investors are assuming Biden will be no problem and everything will be better, but there are geopolitical risks, such as Biden’s stance on the South China Sea and Hong Kong, which could create instability in the region and impact Japan.” He adds: “How Biden approaches China on technology is going to be really important.”
However, SuMi Trust’s Ogawa believes that while US-China relations present a risk to Japanese equities, the impact will be limited, as companies have not stopped their capital investments since the outbreak of the trade war in 2018.
“On another positive note, the election of Biden will likely ease tensions between the US and Europe, thus bringing more optimism for investors,” he says.
Motonobu Hoshino, chief investment officer at Asset Management One, believes that Japan’s fundamentals are strong due to the upswing in the global manufacturing cycle and abundance of such stocks in the Japanese market. However, Japan relies heavily on trading with Asia, particularly China.
“Global manufacturing trends and US-China relations could therefore strongly affect the Japanese market as it moves together with global stocks,” he says.
Suga’s other key policies include revitalising local economies by promoting tourism and transportation and consolidating regional banks. “The banking reforms could encourage investors to buy related stocks,” says Hoshino. “Hotel REIT stocks also look attractive.”
Looming elections risk
Japan must hold a general election by late October 2021, when the current term for lawmakers in the lower house expires. Fund managers are divided on how big a risk the political situation poses.
“Although Suga is seen as a temporary replacement for ex-prime minister Abe due to illness, the political situation does not seem to be unstable,” says Hoshino, adding that the approval rating of Suga and his Liberal Democratic Party (LDP), as well as the ruling coalition, is high.
“Having elections next year will be good for investors as it will discourage policies which place burdens on people, such as raising taxes.”
When the election is called, SuMi Trust’s Ogawa believes the LDP is very likely to win again and Suga will retain his administration. “However, this will be the first election for Suga and there may be turmoil in case of an unexpected outcome, such as a drastic loss of seats for the LDP,” he says.
“In addition, although the Tokyo Olympic Games are set to be held next summer, there are still uncertainties due to the current pandemic. Should the games be cancelled, market sentiment would be negatively affected.”
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