What has changed in Japanese Equities?
Article | 04 November 2016
How has a shift in Japanese equity market drivers affected investors?
In recent times, we have seen a significant change in the sectors driving the Japanese equity market. The higher quality sectors with stable earnings, which were among the better performers this year, have suffered recently from widespread profit taking. At the same time, some of the more economic and currency sensitive areas of the market have rallied.
The reasons behind this shift in focus included more optimism that the government’s expenditure policy and Bank of Japan’s (BoJ’s) ongoing low interest rate policy could have a positive impact on the Japanese economy. Prime Minister Abe unveiled a substantial expenditure programme aimed at stimulating the economy, while the BoJ announced it would continue to keep interest rates low until the inflation rate moves above 2%. Furthermore, the bank also decided not to push interest rates further into negative territory, at least at the current time, which should alleviate some downward pressure on earnings at financial institutions. These companies have seen their profits suffer as lower rates caused spreads, the differential between loan and deposit rates, to decline. At the same time, lower interest rates have increased the size of pension fund liabilities, and this has negatively impacted corporate earnings.
A further reason behind the shift in the sectors driving the market was the increasing likelihood that the next move in US interest rates will be upwards. This is expected to cause the US dollar to strengthen against the yen, particularly as, in our view, low interest rates are likely to remain in place in Japan for some time to come. This resulted in those sectors that benefit from a weaker yen to outperform, and the defensive sectors which generally do not, to decline. Also, in several cases the differences in sector performance have been due to an increase in the valuation differentials between the defensive and cyclical stocks, given the lengthy period of outperformance by the former.
How is the Invesco Perpetual Japan Fund positioned? Although we retain a cautious view on the Japanese equity market, in recent months the fund’s tilt towards defensive stocks, such as Japan’s real estate investment trusts (J-REITS), has been reduced. We have selectively added to areas such as banks, insurers and auto-manufacturers where we see greater upside potential. Importantly, many of these stocks possess valuation levels which we believe already reflect the challenging economic backdrop. Although we still retain positions in some defensive sectors where we see reasonable valuations and visible earnings, such as rail companies and tobacco, the fund’s exposure is now more evenly balanced.
Looking forward, valuation multiples for the Topix index are undemanding relative to history and to other developed equity markets, but we believe that earnings growth for Japanese corporates is likely to remain subdued and sensitive to the exchange rate. In addition, any sustainable improvement in domestic economic growth will depend as much on global conditions as on domestic policy. Despite our current cautious view on the overall equity market, we are able to find companies with attractive medium-term earnings growth which we feel is not adequately reflected in their share prices. Finally, total shareholder returns are rising as many companies are paying out more of their earnings in the form of dividends to shareholders and undertaking share buybacks. This adds support to the investment case for the market as a whole.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
The Invesco Perpetual Japan Fund may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of the fund. The Manager, however, will ensure that the use of derivatives within the fund does not materially alter the overall risk profile of the fund.
Where Paul Chesson has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco Perpetual investment professionals.
For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the Annual or Interim Short Reports and the Prospectus, which are available from the Literature section.