Prime Minister Shinzo Abe’s resignation, volatile overseas markets, worries over a slowing US economy, weak quarterly GDP figures and selling by both domestic and overseas investors had a negative impact on the Tokyo market in August and September. Given that the Japanese market has already been lagging behind other major stock markets for more than a year, many are now suggesting that Japanese stocks will never recover and should be avoided indefinitely.
But given this near consensus of negative sentiment, is now the ideal time to be buying selected Japanese equities?
Uncertainty over Japan’s long-term outlook has certainly scared away many investors, both domestic and overseas. However, one lesson that history teaches us is that major markets recover and those who invest in the bad times make good returns. It may be too early to call the bottom of the current cycle, but the market does seem to be in a bottom zone and we like the idea of buying when others are pessimistic.
As long-time investors in Japan well know, consumer spending, which accounts for more than 50 per cent of GDP, has been under pressure since the early 1990s, as a result of a prolonged period of deflation. The extended drop in asset prices not only reduced the store of wealth of households, it also led to heightened anxiety on the income front, as corporations were forced to restructure, putting more into unemployment and capping income gains for those remaining in work.
While consumer spending is increasing at a relatively slow pace, the prolonged downtrend in asset prices finally appears to be coming to an end, with property prices in major cities now stabilising or moving higher. Households are also starting to see improvements on the income side, as consecutive years of earnings growth has put corporations in a position to increase the hiring of full-time employees and, going forward, slowly increase wages, overtime hours and bonuses for existing employers.
We are hoping Japanese consumers will increase their spending but, even so, we would expect any recovery in spending to be relatively slow and to occur only if wages rose, overtime work increased and sentiment improved.
Other fundamentals look more promising. The economy looks set to grow by about 2 per cent in real terms this fiscal year and next, though a weak world economy and poor domestic economic policy would probably result in annual growth of about 1–1.5 per cent. Therefore, even in a worse-case scenario, the economy looks relatively strong.
Corporate earnings should increase by more than 10 per cent this year. Private capital expenditure and exports are strong, while confidence among bigger and medium-sized companies also seems to be improving. At current prices, many stocks are attractive, especially for long-term investors.
Furthermore, the yen will not weaken forever, which will bring investors back to the stock market. There are a number of reasons why it is likely to appreciate, including both a current account and trade surplus, and interest rates gradually moving upwards as US interest rates move sideways or downwards. In any event, Japanese companies remain very competitive.
There are potential risk factors that could negatively affect the Japanese market. Higher commodity prices hurt Japanese manufacturers, and exporters are dependent on the US as well as China and other Asian countries.
Recent political turbulence has also made investors nervous. It will probably take several months to understand where new prime minister Yasuo Fukuda plans to lead the nation, but at this time we would expect only a few gradual changes over the next year or so. We do expect Mr Fukuda to pay more attention to the economy and business, both of which Mr Abe tended to neglect. However, as in the past, the Japanese bureaucrats will continue to have considerable influence.
There are undoubtedly uncertainties that exist in the Japanese economy and market and these have contributed to poor stock market performance. However, unless you think the yen is going to weaken forever or that Japanese companies cannot compete, you shouldn’t write off the Japanese market.
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