Nicholas Weindling, fund manager, JPM Japan Fund and JP Morgan Japanese Investment Trust
Japanese equities have carved out a significant winning streak so far this year, in yen terms but notably also in all other major global currency term. We think the outlook for further gains from these levels is strong.
There are several pillars holding up this view: monetary policy is supportive and market-friendly, parts of the economy are improving, Japanese companies are and likely will continue achieving record profits, market valuations are not expensive and corporate governance is improving significantly.
The Bank of Japan remains aggressively committed to generating inflation, and that support will continue pushing up asset prices. Meanwhile, the economy is starting to slowly recover from the consumption tax impact and benefit from the impact of falling oil prices, which helps Japan meaningfully as they are a net oil importer.
Employee wages are on the rise. Wage growth gains have been increasing modestly from low levels, but it’s the most significant increase we’ve seen since 1998. We also sense from talking to companies that they see the labour markets getting much tighter.
Japanese equities are generating record profit levels and the market has been consistently upgraded by analysts in the last two years. Overall valuations have hardly moved at all even as the market returns have gone up a lot, so the market doesn’t look overly expensive at current levels.
We think that the most important reason that Japan can finally begin to close the gap with Europe and the US is down to the corporate governance reforms that are underway. In addition to all of the cyclical factors that are bolstering Japanese equities, the governance reforms are really a structural change. In relatively quick succession, we’ve see the creation and implementation of four major reforms that are changing the shareholder landscape:
- The new JPX – Nikkei 400 index (otherwise known as the “shame index”) emphasising Return-on-Equity (ROE) and governance factors as stock selection criteria
- The Fiduciary responsibility code for investors, where 160 institutional investors have already signed up
- The introduction of best practice guidelines for governance behaviour for listed companies
- New Institutional Shareholder Services (ISS) voting guidelines advising a 5% ROE threshold in the Japan voting guide and advising shareholders to vote against firms without at least two outside directors
Meanwhile, because global investors haven’t looked at Japan as a significant returns opportunity for so many years, there are disproportionate opportunities for active managers, particularly those with an on-the-ground presence in Japan. In short, analyst coverage of Japan is nothing short of pitiful, despite Japan being the world’s second largest equity market.
For example, nearly one half of the entire TOPIX currently has either just one analyst covering it or ZERO analysts!
Exacerbating this, where there are analysts in Japan, most often they are covering the wrong companies. Most are looking at the leaders of the last generation of growth in Japan, rather than covering the future leaders. A great example is Cannon. While the company maintains a global leadership in cameras, that sector is hardly a major growth area.
Hence active managers have a great opportunity in this market to look beyond the index to unearth interesting opportunities. An example of this is how we are currently playing the driverless car theme, where we are seeking out investment opportunities beyond a conventional industry sector framework.
It might have been true 20 years ago that Japanese big three (Toyota, Honda and Nissan) were superior to the rest of the world, which would have suited a straightforward investment in the major manufacturers, but that is no longer the case today.
However, under the bonnet there are exciting changes happening. For example, the market for electronic cars is rapidly evolving and Japan has many of the leading high-tech companies to supply key electronic components to auto makers. Also, specialist manufacturers of things like safety devices that help you park or provide assisted driving through internet connectivity are a differentiated way to play the story.
Finally, the single most significant change outside of corporate governance in Japan is the massive swell in tourism. Tourism from China is up an astounding 80% and represents a profound new area of demand. For example, Fukuoka, a gate city in the Kyushu Island with 1.5million residents, welcomes 1.5million tourists, notably from China, per year.
More than 200 cruise ships visit the city and tourists come on a shopping spree as a cruise ship does not have weight limits on their luggage. The economic contribution of tourism today in Japan is roughly the equivalent of adding 1.5 million people to the population because they spend so much money in Japan!”