A Japanese Goldilocks?
Ever since the Japanese bull market kicked off in late 2012, global asset allocators have been able to put the market on the back burner as equity gains have been eroded by yen weakness. Despite two years of aggressive monetary easing and a 70% rally in stocks, Japanese stocks still only matched global benchmarks (MSCI Japan versus MSCI AC World in US dollar terms). However, there are good reasons to think that this negative correlation between stocks and the yen could be breaking down. As a result, continuing to ignore Japan could prove painful.
So far this year MSCI Japan has jumped 8%, beating major developed market peers. The rally also occurred despite the yen strengthening against the euro. This is a decisive shift that appears to break the inverse yen-equities correlation which has broadly applied for more than a decade. This shift looks to be partly a function of Japan’s rotation from bonds to equities; the Bank of Japan’s bond buying programme will have directed funds into risk assets and so too will the Government Pension Investment Fund’s increased weighting in equities. The new factor is the heightened participation of domestic investors, whose more thematically driven investment approach offers a counter point to the on/off style of foreign investors, based on currency movements. Granted, domestic interest in Japan can prove fleeting (the consequence of a 20 year structural bear market), while the macroeconomic outlook is hardly outright bullish. Still, the US experience of the last five years has shown that a “Goldilocks” scenario for equity investors can result from an economy that is generating growth, but is not so hot as to disturb central bank easing policies or cause a richly valued bond market to suffer destabilising volatility.
Such a Goldilocks scenario can prove durable so long as corporates continue to deliver earnings growth. Indeed, Japan is among the few major markets that are seeing earnings upgrades, with investors expecting forward EPS growth of 10%. This positive outlook should continue to be supported by a competitive yen, the collapse in commodity input costs and a sequential improvement in real wages that feeds into firmer domestic demand. Even the Japanese electricity generators, which have suffered due to their reliance on imported fuel, are now operating close to breakeven levels, and have seen a leap in their earnings expectations.
Investors are also getting more cash back from their Japanese equities as a genuine shift in the corporate governance climate forces, at long last, a greater focus on shareholder value. It is no longer unusual for Japanese firms to raise dividends and make share buybacks; aggregate buybacks (so far announced) have risen 49% YoY in the half year financial period ending on March 31. Aggregate dividends paid to investors records were started.
Japanese companies have plenty of scope to expand this return of cash as trillions of yen are squirreled in bank deposits. With the upside for bonds and money market products being limited by record low yields, we would expect this “not too hot, not too cold” scenario to result in domestic investors taking on a more “normal” equity exposure.
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