Japan Growth Fund manager Masaki Taketsume explains why he expects a return to a more normal market environment, in which individual stock-specific factors are the primary driver of long-term stock price returns.
- Policy stability to be maintained
- Cyclical headwind on earnings likely to ease in 2020
- Valuations attractive and foreigners likely to take more positive view
There is an endless debate about whether ‘Abenomics’, a term used to describe prime minister Shinzō Abe’s aggressive policy approach to rejuvenate the economy, has delivered the intended benefits for Japan.
But in political terms, we must acknowledge that his tenure has been a marked success. He has recently become Japan’s longest-serving prime minister and has sustained a level of popularity that eluded all his recent predecessors.
This is important because as we move beyond the Tokyo Olympics in August, the end of Mr Abe’s term in 2021 will be within most investors’ time-horizon.
It is not yet known who his successor will be but the Liberal Democratic Party, which Mr Abe leads, is almost guaranteed to retain power given that all the opposition parties remain in disarray. As a result, while we may need to find a new phrase to replace Abenomics, we are confident there will be strong continuity in fiscal and monetary policy, even with a new leader.
For 2020, there is some uncertainty over what the prime minister will look to achieve in his remaining time in office. It is widely known that his personal ambitions include reform of Japan’s constitution but there is little evidence so far that he is building the kind of consensus he would need to get this done.
As equity investors, we would much prefer his efforts to be focused on more pressing economic reforms and would regard anything else as a distraction. Short-term economic decisions will centre around the scale of additional fiscal stimulus, as evidence of the impact from the increase in consumption tax on 1 October becomes clearer over the coming months.
With Haruhiko Kuroda remaining as governor of the Bank of Japan, we expect no change in direction of monetary policy this year. Additional easing, including cutting short rates further into negative territory, is possible, especially if any strengthening of the yen generates renewed downward pressure on inflation.
However, the central bank is keenly aware of the damage negative rates are inflicting on the financial sector and may look to mitigate this impact by engineering some steepening of the yield curve. We also expect the Bank of Japan to maintain its target level for equity purchases through exchange-traded funds (ETFs) in 2020.
The bank has stepped back from the market during the most recent rally and may therefore fall short of its purchase target for 2019. As a result, while corporations have been significant net buyers in 2019, in the form of share buy-backs, market dynamics have changed in the last couple of months. Foreigners have replaced the Bank of Japan as the other dominant investor group.
We expect share buy-backs to continue at high levels this year as the trend towards stronger corporate governance and shareholder accountability continues. We also see this beginning to drive corporate activity – there were some particularly interesting group restructurings and hostile takeover attempts in 2019.
Of course, these could be viewed as just isolated events, and the fact we still find them unusual suggests this may not yet be a sustainable trend. Nevertheless, we could well be looking back at 2019 and 2020 as defining moments in Japan’s transition towards levels of activism and engagement that we take for granted in other developed markets.
Unfortunately, the path to better governance appeared to be interrupted in October by the announcement of tighter restrictions on foreign investment into a very broadly defined range of ‘security-related’ industries. Although the new regulations are aimed at protecting these industries from undue foreign influence, we recognised the potential for significant collateral damage to foreign asset managers and, by extension, to the equity market.
The situation continues to evolve through dialogue with the authorities and a series of clarifications, which now suggest to us that this change will ultimately have much less impact on the market than we initially feared. But there will be some negative implications for foreign activist investors who will face an additional administrative burden.
We continue to engage with the authorities on this issue but need to wait to see the actual regulatory framework and a definitive list of companies ahead of the final implementation, which is likely to be in April.
Aside from this unexpected blip, we should anticipate greater interest from foreign investors to follow through. In the last 12 to 18 months, Japanese stock prices have been penalised by investors’ risk-aversion at a time of global cyclical slowdown. As we are now beginning to see less downward pressure on earnings revisions, we can also expect foreigners to take a more positive stance.
Against historical levels, Japan’s market valuations look reasonable, but our feeling is that we may need better visibility on near-term earnings growth to drive the market up to the next level. But against other developed markets, Japan continues to offer very good value – although this has been the case for so long that we all seem to regard it as ‘normal’.
Nevertheless, we do have conviction that the moves towards better governance and better capital allocation will improve companies’ return on equity and ultimately remove the discount at which Japan has consistently traded in recent years.
We also look for conditions within the market to normalise. Investors’ strong preference in recent years for quality and stable growth stocks has resulted in distorted valuation differentials and these ‘style factors’ have tended to be the dominant influence on stock prices.
Even without any sharp reversal in factor leadership, we should expect a return to a more normal environment in which individual stock-specific factors are the primary driver of long-term stock price returns.
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