Furthermore, the fall in oil prices also augurs well for the country, which is the world’s second largest oil importer on a per capita basis.
The Japanese market surged to a seven-year high during the first week of November, following the expansion of the stimulus programme and the decision by GPIF, Japan’s $1.2trn pension fund, to raise equity allocation targets.
But portfolio managers do not find the markets expensive, even after this rally.
Kevin Gibson, chief investment officer-equity at Eastspring Investments said Japanese equities look undervalued in relation to the corporate earnings growth prospects.
“Corporate Japan is delivering strong earnings growth, which has yet to be reflected in higher share prices. Japan’s share market rallied on improving fundamentals in 2013 and into 2014, however valuation has not rerated.”
Similar views are shared by other asset managers like Schroders, Pinebridge Investments and Neptune Investment Management.
“Despite the recent setback after April’s consumption tax hike, evidenced by an unexpected two negative quarters of GDP [gross domestic product] growth, we remain positive on the improving trend of Japan’s economy,” said Shogo Maeda, head of Japanese equities at Schroders.
Many exporters are still factoring in an average dollar/yen rate of around 100-105 yen – while the current exchange rate stands at around 118 yen to the greenback, which can uplift the earnings of companies, Maeda said.
Sector focus
Eastsrping investment said it goes into 2015 with high conviction positions in Japan’s major banks.
“We see many very attractively valued companies with sound fundamentals and strong balance sheets, attributes so far unrecognised by investors. In addition, we observe the restructuring many Japanese companies are undergoing. This is a powerful combination.”
Schroders is watching valuations while focusing on companies expected to have sustainable mid- to long-term earnings.
This, Maeda said, would preferably come through company-specific growth drivers as opposed to just betting on the cyclical recovery or macroeconomic tailwinds, such as a weaker yen.
“We are finding cyclical stocks including autos, electrics, and some parts of machinery attractive, given their potential for upward revisions to earnings, while being mindful of valuations.”
Schroders also like trading companies and financial stocks given their cheap valuations.
“Turnaround opportunities among out-of-favor stocks are also an area where we see additional investment ideas as we go into 2015,” Maeda added.
Oil impact
Chris Taylor, investment director and head of research at Neptune Investment Management, said the fund has a high conviction for Japan, which is the second largest position in their global fund portfolios.
Apart from the surging corporate earnings, weakening yen and structural changes, the precipitous fall in the oil price is another reason to increase Japanese exposure.
The decline in price can help both major industrial companies and consumers.
“Now is a good time to review your Japan exposure if you want to be positioned to benefit from this before the rest of the market moves,” Taylor said.
“The oil price fall will help Prime Minister Shinzo Abe move the economy out of the short-term recession triggered by the recent sales tax hike, effectively offsetting some of its impact,” Taylor said.
The medium-term support for the Japanese market is significant and Neptune believes that sustainable low oil prices will increase the speed at which the market moves to reward Japanese companies that are highly rated.
Structural changes
According to Markus Schomer, chief economist at PineBridge Investments, the expansion of the asset purchase programme, deferral of consumption tax increase to 2015 and weaker yen could pull the economy out of recession.
Maeda of Schroders sees a recovery in domestic consumption.
“Given that the second consumption tax increase has now been postponed, we believe the benefits of higher wages over the next two years will start to feed through to the real economy and that this will result in a solid recovery in domestic consumption next year,” he said.
Furthermore Maeda thinks the tightening labour market continues to suggest constant wage growth, which he thinks will support the inflationary trend that the Bank of Japan has targeted.
On any cut in corporate tax rate, Maeda said, “With Japan’s corporate tax rate among the highest in the world’s developed economies, a reduction in the top rate from the current 35% to less than 30% over a period of a few years could continue to support corporate earnings in the medium-term.”
