World investment outlook 2017: Japan

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Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

The world investment outlook is written by Russ Mould, AJ Bell Investment Director and contains a wealth of information on the world financial markets and events to help with your investment strategies in 2017.

Here he considers the outlook for Japan.

Japan is where no Western investor or central banker wants to go, at least in terms of its 25-year struggle against deflation, a fight which Prime Minister Shinzō Abe and the Bank of Japan are still working hard to win.

The three key issues for 2017

  • Monetary policy and whether the Bank of Japan persists with negative interest rates and quantitative easing
  • The Japanese yen and whether it will continue to fall, as the Bank of Japan would like
  • Corporate cash piles and to degree to which Japanese firms crank up their dividend and share buyback policies

Politics

The snap election of December 2014 for the lower House of Representatives and summer 2015’s scheduled ballot for the upper House of Councillors mean Prime Minister Shinzō Abe and his Liberal Democratic Party (LDP) and its coalition partners enjoy a super-majority in both sections of the Diet, or Japanese Parliament.

Prime Minister Abe’s LDP and partners have a supermajority in both houses of the Diet

  House of Representatives House of Councillors
Government
Liberal Democratic Party 291 121
Komeito 35 25
326 146
Revisionist opposition
Initiatives 14 12
Party for Japanese Kokoro 0 3
14 15
Opposition
Democratic Party of Japan 96 49
Japan Communist Party 21 14
Social Democratic Party 2 2
PLP 2 2
Energize 0 2
121 69
Independents 14 12

Source: Asahi Shimbun

Abe is using this position of strength to focus on his three-pronged ‘Abenomics’ programme, where he is backed to the hilt by Bank of Japan Governor Haruhiko Kuroda. This involves:

  • Huge fiscal stimulus and infrastructure spending programmes
  • Huge monetary stimulus, initiated with the relaunch of QE by the Bank of Japan five months later
  • Structural reform across areas such as employment law, agriculture, tax, energy and foreign direct investment

Yet the PM’s economic policies have yet to sustainably boost either economic growth or inflation by any noticeable degree.

Abe must therefore keep an eye on the new leader of the opposition Democratic Party of Japan (DPJ), Renho Murata. Anti-nuclear and a known opponent of the Trans-Pacific Partnership trade deal, she is shrewdly positioning herself as the champion of younger voters, something her previous career as a TV newsreader and huge social media following leave her well placed to do.

In theory Renho has until December 2018 to prepare for the next general election, although there are rumours that Abe may go with yet another snap poll in 2017, not least as his three-year term as LDP party President expires in September 2018.

Economics

GDP growth remains patchy and 25 years of weak growth and multiple rounds of fiscal stimulus since its stock and property market bubbles popped in 1989 have left Japan with a sovereign debt-to-GDP ratio of around 260%, a figure which makes even Greece look good.

Japanese GDP growth looks uneven at best

Japanese GDP growth looks uneven at best

Source: Thomson Reuters Datastream, Trading Economics

Moreover, inflation is nowhere near the 2% target laid down by the Bank of Japan (BoJ). After six straight months of falling prices, or deflation, consumer price rose 0.1% in October, but that hardly suggested Abenomics was delivering.

Japan is mired in deflation once more

Japan is mired in deflation once more

Source: Thomson Reuters Datastream

Bad luck, in the form of the 2011 and 2016 earthquakes, has not helped, but Abe and his colleagues are still confronted by terrible demographics (in the form an ageing population) and that crushing sovereign debt pile.

The Bank of Japan (BoJ) is doing what it can to make the debt mountain manageable, by slashing interest rates to -0.1% and driving bond yields lower with its Qualitative and Quantitative (QQE) monetary policy experiment, which is also designed to force down the yen, to boost exports.

Japan took interest rates into negative territory in January 2016

Japan took interest rates into negative territory in January 2016

Source: Thomson Reuters Datastream

But bond yields have stopped falling. This suggests that investors think the BoJ may stop adding to, or even begin to retreat from, its ¥80 trillion-a-month QE programme, just as the US Federal Reserve looks at fresh rate increases and the European Central Bank debates whether to taper its own QE scheme.

Where Japan goes next will potentially have lessons for us all, especially as faith in QE and record-low or negative interest rates seems to be wobbling a little in the West, where fiscal stimulus is becoming the new narrative, as evidenced by comments in favour of it from US President-Elect Donald Trump and the UK’s Prime Minister Theresa May in particular.

Markets

Japan’s Nikkei 225 still trades at less than half of its 1989 all-time high, some 27 years after its debt-fuelled property and equity bubble popped. Yet it also trades at nearly twice the level reached just before Prime Minister Shinzō Abe became Prime Minister in late 2012.

The Nikkei 225 still trades at less than half of its 1989 all-time peak

The Nikkei 225 still trades at less than half of its 1999 all-time peak

Source: Thomson Reuters Datastream

Sceptics argue that the economic and earnings growth witnessed under Abenomics has been simply the result of officials’ attempts to talk down the currency. The relationship between the Nikkei 225 and then yen does seem clear so anyone buying Japanese stocks needs to consider this. Some funds do offer a currency hedge, albeit in exchange for a fee.

Under Abe the Nikkei 225 and the yen have tended to move in opposite directions

Under Abe the Nikkei 225 and the yen have tended to move in opposite directions

Source: Thomson Reuters Datastream

Relative to its British, American and European equivalents, Japan’s stock market does not look expensive and a move by corporations to engage with shareholders more fully and also start to return surplus cash more generously provides a decent dividend yield, at least by local standards.

The Japan Times newspaper estimates that Japanese firms are still hoarding more than ¥340 trillion (£2.7 trillion) in cash, around 60% of GDP.

This underpins the value case made by bulls of Japanese stocks. Consensus forecasts suggest the market is trading on barely one times net asset (or book) value - at a time when most of those assets are cash.

A forecast dividend yield of some 2.2% is augmented by share buybacks, which are reaching all-time record levels. Add the two together and Japanese companies are returning around 5% of their aggregate market cap in cash, an unprecedented figure.

The problem is that we have been here before, as evidenced by several large but ultimately failed rallies in the Nikkei which have ultimately led optimists astray. As such the battle lines are drawn between those who argue Japan is a debt-riddled, demographically-challenged busted flush and those who assert the country’s equity market is rich in potential, thanks to Abe’s three-pronged top-down reform programme, a central bank that is determined to stoke economic growth and inflation and a major bottom-up shift in corporate culture

A sustained upturn in both GDP and inflation data would be positive sign that Abenomics is working. Fresh gains in the quarterly Tankan business confidence survey would also be helpful as it might suggest that corporations are ready to start spending some of their massive cash pile.

In addition, the indicator seems to correlate well with the headline Nikkei 225 stock index.

Fresh gains in the Tankan business sentiment survey could be a good sign

Fresh gains in the Tankan business sentiment survey could be a good sign

Source: Bank of Japan, Thomson Reuters Datastream

Top-performing funds

Best performing Japan Large Cap OEICs over the last five years

OEIC Fund size £m Annualised 5-yr performance  12-month Yield OCF Morningstar rating 
Baillie Gifford Japanese B (Inc) 1,496.3 17.1% 0.67% 0.68% *****
M&G Japan Sterling I (Inc) 251.9 16.2% 1.08% 0.94% ****
Ruffer Japanese C (Acc) 440.7 16.1% 0.30% 1.24% **
GAM Star Japan Equity Institutional GBP (Acc) 93.9 15.3% n/a 1.59% ****
Henderson Japan Opportunities I (Acc) 26.0 15.1% 2.38% 0.85% *****

Source: Morningstar, for Japan Large Cap category
Where more than one class of fund features only the best performer is listed.

Best performing Japanese investment trusts over the last five years

Investment Trust Market cap £m Annualised 5-yr performance Dividend yield Gearing OCF*  Discount to NAV Morningstar rating 
Baillie Gifford Shin Nippon 225.9 29.8% n/a 9% 1.02% 9.3% *****
Baillie Gifford Japan 444.5 24.6% n/a 15% 0.88% 2.8% *****
Schroder Japan Growth 222.4 17.5% 1.6% 10% 1.12% -10.1% ****
JP Morgan Japan Smaller Companies 141.8 16.6% n/a 17% 1.42% -15.5% **
JP Morgan Japanese 518.4 16.7% 1.1% 11% 0.77% -10.3% ****

Source: Morningstar and the AIC, for Japan and Japanese Smaller Companies Categories.
* Includes performance fee

Best performing Japanese Equity ETFs over the last five years

ETF Market cap £m Annualised 5-yr performance Dividend yield Total Expense Ratio Morningstar rating  Replication method
iShares Nikkei 225 UCITS ETF JPY (Acc) GBP 118.5 13.6% n/a 0.48% ***** Physical
iShares Core MSCI Japan IMI UCITS ETF USD (Acc) 1,247.8 12.4% n/a 0.20% **** Physical
iShares MSCI Japan UCITS ETF USD (Acc) GBP 256.4 11.9% n/a 0.48% **** Physical
Source MSCI Japan UCITS ETF USD 23.9 11.9% n/a 0.40% **** Synthetic
db x-trackers MSCI Japan Index UCITS ETF (DR) 1C USD 917.5 11.8% n/a 0.50% **** Physical

Source: Morningstar, for Japan Large-Cap Equity and Japan Small/Mid-Cap Categories. Where more than one class of fund features only the best performer is listed.

Read more from our world investment outlook 2017 series:

World investment outlook 2017: UK

World investment outlook 2017: USA

World investment outlook 2017: The rest of the world

World investment outlook 2017: Europe


russmould's picture
Written by:
Russ Mould

Russ Mould has 28 years' experience of the capital markets. He started at Scottish Equitable in 1991 as a fund manager and in 1993 he joined SG Warburg, now part of UBS investment bank, where he worked as equity analyst covering the technology sector for 12 years. Russ joined Shares in November 2005 as technology correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media by AJ Bell Group, he was appointed AJ Bell’s Investment Director in summer 2013.