Here are seven ideas on Japanese equities
The japanese stock market and the yen exhibit a high correlation coefficient, as is only natural since the Empire of the Rising Sun is Asia’s export colossus. So the election of LDP Prime Minister Shinzo Abe in November 2012 was a game-changer for both the Nikkei Dow/Topix stock market indices and the yen. Abe handpicked Haruhiko Kuroda, the chief executive of the Asian Development Bank in Manila, to be the governor of the Bank of Japan. The BoJ, in turn, engineered one of the most aggressive quantitative easing programmes in the history of world finance, the fabled “second arrow of Abenomics”. The Japanese yen fell from 78 against the dollar on the eve of Abe’s election to 113.6 now. Even though Kuroda-san did not achieve his target for a two per cent inflation rate, the Bank of Japan’s epic depreciation of the yen has enabled the Nikkei Dow index to more than double since Abe’s election to a recent high of 19,800.
2017 has not been kind to Japanese equities. A safe-haven bid in the Japanese yen saw it rise from 118 to as high as 108, making it impossible for the Nikkei Dow bulls to propel the index significantly higher. Toshiba’s fall from grace, the Takata scandal, geopolitical tensions with North Korea and Trump’s veto of the Trans-Pacific Partnership are all bearish data points for Japanese equities. However, on any 1,000-point Nikkei Dow correction caused by a spasm of risk aversion. I believe the Japanese stock market is a value buy in the constellation of the developed markets. Why?
One, Japanese economic growth is accelerating. The Japanese GDP growth rate could well be two per cent in 2017. The Tankan survey is the strongest in the past decade. Exports have risen at double-digit rates despite the stronger yen and a protectionist Trump. Japan has finally emerged from “two lost decades” dismal growth and mild debt deflation.
Two, Shinzo Abe’s government has boosted fiscal stimulus, mainly road construction and infrastructure spending, as a prelude to the 2020 Tokyo Olympics. This is another factor that will anchor Japan’s two per cent economic growth rate.
Three, Japan’s trillion-dollar Government Pension Investment Fund continues to increase its allocations to domestic equities while reducing its holdings in the Japanese government bond market, which is almost comically overpriced, thanks to Kurodasan and the BoJ’s asset-buying spree. Life insurers, trust banks and Asian fund managers are also using any pause in the Nikkei Dow bull run to add to their positions in Japanese equities.
Four, Japanese equities could well offer 15 per cent earnings growth in 2017-18, higher than on Wall Street or even Europe. Earnings momentum revision has now begun to accelerate. This is hugely positive for Japanese equities and makes a Topix target of 1,800 by mid-2018 credible.
Five, the Federal Reserve will raise its policy borrowing rate at least twice more in 2017 while the Bank of Japan will do nothing to end its “zero yield” yen money market policy. This means the Japanese yen could well fall to 122 against the US dollar by end 2017, a bullish omen for Japanese equities.
Six, labour markets have begun to tighten in Japan. This is a bullish omen for consumer inflation. The unemployment rate is now 2.8 per cent, the lowest since 1995. Average hourly earnings have begun to rise, a key Bank of Japan policy objective. Inflation is a steroid shot for Japanese equities. As consumer inflation rises but the Bank of Japan continues its debt buying program. This will reduce the real (inflation-adjusted) yields in the money markets, accelerate the depreciation of the yen and thus boost Nikkei Dow/Topix indices.
Seven, I have a rule of thumb. When the equity risk premium in Japan rises to seven per cent, I must go long Japan — yenhedged, of course! The equity risk premium in Japanese equities now 7.8 per cent. Japanese equities now trade at a 12.8 times forward earnings at a time when EPS growth rates, operating margins and returns on equity will rise. Relative to the American stock market, Japan is a steal. I expect the valuation case for Japan will strengthen once the fallout from the Toshiba debacle ends as better corporate governance norms, higher profits and the paradigm of shareholder value reshapes Marunouchi. As the spring cherry blossoms fall on Mount Fuji, it is time to buy (yenhedged) Japan!