making the case: active allocation to japanese equitiesmaking the case: active allocation to...
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FOR PROFESSIONAL CLIENTS AND IN SWITZERLAND, FOR QUALIFIED INVESTORS ONLY
Making the case: Active allocation to Japanese equities
Making the case: Active allocation to Japanese equities
2
1 Abenomics is the economic policy embracing fiscal and monetary stimulus unveiled in 2013 by Shinzo Abe, Japan’s prime minister.2 Source: Russell/Nomura, accessed as at 31 January 2018.
I. A positive macro backdropEconomic growth has seen Japan go from zero to hero in recent years. Most notably, nominal GDP growth YoY has now been positive for 21 consecutive quarters.
For Kashima, this spurt of growth is a major milestone. After many years in the doldrums, nominal GDP is above ¥533 trillion, meaning the economy has finally recovered the ground lost over two long decades of decline.
“GDP has recovered very nicely since start of Abenomics1, and at last we’re back to the level of 1997 when deflation started,” she says. “Even so, we still have a long way to go before we reach the government’s nominal GDP target of ¥600 trillion so there’s no reason for a change in direction just yet.
“If you step back and look at what the government promised on the economy and what it’s actually achieved, it’s pretty impressive. We think it points the way to a positive outlook for investors.”
NOMINAL GDP GROWTH YOY HAS BEEN POSITIVE FOR 20 CONSECUTIVE QUARTERS
450
475
500
525
550
575
600
2025
2023
2021
2019
2017
2015
2013
2011
2009
2007
2005
2003
2001
1999
1997
-10-505101520253035404550
YoY (RHS) Nominal GDP (LHS)
Abenomics starts in 2012
Recovered to1997 level
GovernmentTarget
600 TrillionYen
Trill
ion
JPY
2. Less dependent on exports than you’d expect…Investors might be forgiven for wondering whether the current global trade war narrative could dent Japan’s positive growth story. But the traditional image of the Japanese economy being dominated by exporting industries doesn’t really stand up to closer scrutiny, says Kashima.
Consider figures from the Russell Nomura Index. The aggregate export ratio of the Russell Nomura Index companies is around 34% based on sales.2 Similarly, World Bank data suggests Japan’s export ration as a proportion of GDP is below that of fellow G7 members the UK, France, Canada and Germany.
“Even now,” says Kashima, “the Japanese equity story for international investors has mostly been about large, export-orientated companies and has essentially been a play on the global recovery. But we argue for a different approach. It’s easy for international investors to overlook, but Japan has a vibrant domestic economy of its own and the companies that do well there can often do so without too much reference to what’s going on in the wider world.”
JAPAN’S RELATIVELY LOW DEPENDENCE ON EXPORTSExports as a percentage of GDP
0%
10%
20%
30%
40%
50%
60%
70%
80%
0%
10%
20%
30%
40%
50%
60%
70%
80%Asia
Exp
orts
in %
of G
DP
Exp
orts
in %
of G
DP
Developed Countries
Thai
land
Mal
aysi
a
Kor
eaP
hilip
pine
s
Chi
naIn
dia
Indo
nesi
a
Ja
pan
Switz
erla
ndG
erm
any
Spa
inC
anad
aFr
anceUK
Aust
ralia
Japa
nU
SA
Source: The World Bank, Bloomberg. Data for Japan, US and Switzerland are as of end of 2015. All other countries are as of end of 2016. Most recent data available.
Miyuki leads the Japanese Equity Team based in Tokyo and is ultimately responsible for all strategies run by the team. Miyuki started her career at Morgan Grenfell (Renamed Deutsche Asset Management) as a Japan equity analyst in 1985. She became a fund manager in 1987 and has focused exclusively on Japanese equities. From 1997 she was the Head of Japanese equities at Chase Trust Bank and moved to Merrill Lynch Investment Managers (Renamed BlackRock) in 2000. She then moved to ING Mutual Funds in June 2009 where she was responsible for managing the process and performance of the Japanese equity team and also helped to enhance the investment process of other products in the Asia Pacific region.
As it continues to bounce back from a prolonged period of contraction, the Japanese economy offers an attractive opportunity set to investors, says Miyuki Kashima, Head of Japanese Equities, BNY Mellon Asset Management Japan Limited.
Source: Economic and Social Research Institute, Cabinet Office, Government of Japan, e = government estimate as of 30 June 2019. Latest available data as of June 2019. For illustrative purposes only. Nominal GDP is a nominal seasonally adjusted quarterly GDP.
Making the case: Active allocation to Japanese equities
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3. Abe will be longest all time PM in historyFor a further reason to be positive on Japan, consider the question of political stability. Japan has gone from being a something of a political basket-case in the mid-2000s to an exemplar of stability today. Between 2006 and 2012, the country had no less than seven prime ministers; more than one a year. That all changed following the election of Shinzo Abe as prime minister in December 2012.
Since then Abe’s LDP party has remained in power, maintaining its two-thirds “supermajority” in the 465-member lower house. In 2019 Abe overtook Katsura Tarō to become the longest serving prime minister in Japan’s history.
This level of stability is a boon, says Kashima, particularly since Abe has committed to maintaining the policies of Abenomics, the mix of fiscal and monetary stimulus that bears his name. “Quite often an election in Japan is followed by wholesale changes to the roster of ministers and their portfolios but this wasn’t a feature of the most recent election,” she says.
4. Wage growth: Picking up the batonAs evidence of the growing strength and confidence of Japan’s business sector Kashima highlights the story told by wage growth data. After decades of stagnation, she says, large cap and international companies are now steadily increasing salaries. Average per-hour wages have maintained an upward trajectory but, crucially, given the decline in the working-age demographic, so has total employee compensation. This is significant for the health of the wider economy, says Kashima, given the interplay between rising income, domestic consumption and business confidence.
TOTAL EMPLOYEE COMPENSATION
Japa
nese
bill
ion
yen
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017240,000
245,000
250,000
255,000
260,000
265,000
270,000
275,000
280,000
285,000
Source: Cabinet Office, Government of Japan, December 2018.
5. Bank lending: the lifeblood of businessIf companies are going to invest in future growth then a benign lending environment is crucial. Here, the Japanese banking sector, with its loan-to-deposit ratio of less than 60% will play an important role. Consider how Japanese banks compare with their international peers. In the US, the loan to deposit ratio might be slightly better at around 70%, but in Europe 16 of 28 countries surveyed by the European Central Bank have average loan-to-deposit ratios above 100%.3
For Kashima this illustrates how Japanese banks have significantly more capacity to free up lending than many of their global counterparts. “It means that if Japanese businesses want to borrow money to maximise their potential, capital is available,” she says. “We believe this will be positive for earnings and growth from here on in.
LOAN/DEPOSIT RATIO: JAPANESE BANKS
45%
55%
65%
75%
85%
95%
0
20
40
60
80
100
120
140
160
180
200
Jan85
Sep88
May92
Jan96
Sep99
May03
Jan07
Sep10
May14
Jan18
JPY
Trill
ion
Loan/deposit ratio
Net deposits (left axis) Loan/Deposit ratio (right axis)Source: Bank of Japan, data ending at the end of August 2019. For illustrative purposes only.
6. Corporate cash build-upsIf banks have cash to spend; so too do Japanese corporates. This is partly due to Japan’s history of deflation: in a deflationary environment it made sense not to invest or spend. Assuming deflation ends and sentiment continues to improve, corporates could be more willing to run down that cash pile – with a positive knock-on effect both for the wider economy and for investors more generally.
ALL CHANGE: JAPANESE PRIME MINISTERS, 2005 – PRESENT
JUNICHIROKOIZUMI2001-2006
TAROASO
2008-2009
YUKIOHATOYAMA
2009-2010
NAOTOKAN
2010-2011
YOSHIHIKONODA
2011-2012
2005 2008 2011 2014 2019
YASUOFUKUDA2007-2008
SHINZOABE
2006-2007
SHINZOABE
2012- present
Source: Bloomberg, December 2017.
3 Forbes: ‘Loan-To-Deposit Ratios For Largest U.S. Banks Show Signs Of Recovery In Q1’, 13 June 2017.
Making the case: Active allocation to Japanese equities
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CORPORATE CASH BUILD-UPCash and deposits held by non-financial corporations
‘97Q4
JPY
Trill
ion
‘99Q1
‘00Q2
‘01Q3
‘02Q4
‘04Q1
‘19Q1
‘05Q2
‘06Q3
‘07Q4
‘09Q1
‘10Q2
‘11Q3
‘12Q4
‘17Q4
‘14Q1
‘15Q2
‘16Q3
150
170
190
210
230
250
270
290
Source: Bank of Japan, data ending at the end of June 2019. For illustrative purposes only.
7. An underappreciated storyDespite the positives, international investors remain significantly underweight Japan. Between April 2003 to April 2006 net purchases of Japanese stocks came in at US$250bn. Between October 2012 to December 2013 that figure had fallen to US$180bn.4 The decline, says Kashima, may be because investors became overly focused on the perceived negatives of the Japanese investment story. Now, as Japan’s economy transitions to growth, that lag-effect looks set to reverse, which in turn could provide a tailwind for Japanese stocks.
But it’s not just international investors that are underweight the stock market. Japanese households also have a very low allocation to the stock market – accounting for just under 11% of household financial assets, according to the Bank of Japan.5 Says Kashima: “Given the performance of Japanese stocks over the past 20 years, this low allocation is hardly surprising. But we think that as the economy continues to improve and as companies continue to perform well Japanese savers will become more interested in buying shares, providing an additional tailwind to equities.”
JAPAN WEIGHTING IN GLOBAL EQUITY STRATEGIESJapan equity weight in global strategies
-5.00
-4.00
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
Jun 17Jun 15Jun 13Jun 11Jun 09Jun 07Jun 05Jun 03Jun 01
Rel
ativ
e w
eigh
t of J
apan
(%) Overweight
Underweight
Source: Nomura Securities Co., Ltd., data ending March 2018. For illustrative purposes only.
8. The good news is not in the price…We’ve seen how Japanese stocks are underappreciated by global investors, but in fundamental terms they also appear to be undervalued. At least this seems to be case if we consider the comparative lag between the performance of Japanese indices and improving corporate earnings. As the chart illustrates, while earnings have recovered, the stock market has only broken out modestly. On this measure at least Japanese stocks appear to offer decent potential for a future uplift in pricing, concludes Kashima.
JAPAN TOPIX VS. TRAILING WEIGHTED EPSJapan equity weight in global strategies
500
1,000
1,500
2,000
-60
-40
-20
0
20
40
60
80
100
120
140
2016
2017
2018
2014
2015
2013
2012
2011
2010
2009
2008
2007
2006
2005
Japan TOPIX (left axis) Trailing EPS (right axis)
Source: Bloomberg, 30 September 2019, using 12 months trailing EPS. For illustrative purposes only.
9. A happy hunting groundGiven the opacity of the Japanese corporate sphere it’s perhaps no surprise that on-the-ground investment teams with in-depth sector, linguistic and cultural expertise tend to do better.
Often even larger companies are “off the grid” in terms of the wider investment community, says Kashima: they may not provide consensus estimates and the company may offer no forward guidance of its own.
Kashima’s team bridges the gap through local knowledge, face-to-face meetings with management and with its own forensic accounting. “We’re interested in opportunities that aren’t on the radar of the average investor,” she says. “Of course, it means you have to be extra careful to avoid hidden obstacles but you also get to discover those hidden gems before anyone else.”
4 Source: Nomura Securities Co., Ltd., data ending November 2017. For illustrative purposes only.5 Bank of Japan, as at September 2017.
Making the case: Active allocation to Japanese equities
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10. A new market phaseThose not convinced that Abenomics is working could do worse than consider the performance of the Nikkei 225 in the years since the Prime Minister launched his overhaul.
After flat-lining for most of the 1990s and 2000s, equity prices have seen a sharp improvement in recent years.
This is evidence of both a change in the mood among investors but also the strength of Japan’s domestic economy, says Kashima. “We believe those equity rises should be sustainable given the resilience of the economy,” she says, “and that Japanese investors will be well positioned for the upside when the global economy eventually bottoms out.”
A CLEAR CHANGE IN MARKET TREND
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
Nik
kei 2
25 In
dex
Abenomics
Source: Bloomberg, data through end of 30 September 2019.
The value of investments can fall. Investors may not get back the amount invested.
Important informationFor Professional Clients and, in Switzerland, for Qualified Investors only. This is a financial promotion and is not investment advice. Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and its subsidiaries. Issued in the UK by BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Conduct Authority. Issued in Switzerland by BNY Mellon Investments Switzerland GmbH, Talacker 29, CH-8001 Zürich, Switzerland. Authorised and regulated by the FINMA. Issued in Europe (ex. Switzerland and UK) by BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML), a public limited company (société anonyme) incorporated and existing under Luxembourg law under registration number B28166 and having its registered address at 2-4 Rue Eugène Ruppert L-2453 Luxembourg. BNY MFML is regulated by the Commission de Surveillance du Secteur Financier (CSSF). MAR000181. T8408 EXP: 31 March 2020 11/19.