Japan – Feature
Because Japanese companies have been conservatively run, there is room for margin improvement.
James McLellan, Border to Coast
vested internationally, a carry trade banking on a persisent yen devaluation. This could backfire if the BoJ were to introduce tightening. But Finn argues that unlike some developed market central banks, the Bank of Japan is quite explicit in saying that it is not responding to inflation by hiking interest rates. It considers the causes of inflation to be rooted in supply side problems, which would be beyond the realm of monetary policy interventions.
In any case, the investment impact of inflation is far from straightforward. While central bank tightening measures could dampen the short-term outlook for equity markets, they would always be weighed against the steps taken by other central banks and as such seen as relatively less severe. Moreover, analysts highlight that Japanese consumers and corporates sit on relatively high cash levels and inflation could encourage increased spending and investment. June-Yon Kim, a portfolio manager at Lazard, predicts that tightness in the Japanese labour market could lead to inflation being much more persistent than currently anticipated.
Nevertheless, he adds that the rise of the dollar remains a wild- card, with little indication that investor demand for the green- back is likely to change. Finn also believes that the Bank of Japan will approach any changes to the country’s currency with great caution: “The BOJ is very, very sensitive to triggering a yen spike or further vola- tility in the yen, or a bond sell off,” he says.
Inflation impact
Another key factor that investors in Japan will have to consider is the impact of rising price levels. For decades, Japan has been defined as a country with persistent deflation. But this could now change. For one, the low value of the yen is driving up import prices, a trend that is aggravated by globally rising energy prices. Japan imports almost 90% of its energy and is therefore extremely vulnerable to global price shocks. But there are also factors that could explain why Japanese inflation has not yet risen to the extent it has in other devel- oped markets. For McLellan, developments in the labour mar- ket could be a decisive factor. “What might ultimately trigger inflation would be an increase in wages in Japan, we have not seen that for quite some time, despite its tight labour market. If you started to see wage inflation coming through, that could be a sign that inflation is starting to take hold and that might precipitate a more aggressive stance from the Bank of Japan,” he says. If monetary policy were to tighten as a result of higher infla- tion, this would, in the first instance, hit Japanese debt mar- kets. Many Japanese investors have borrowed in yen and in-
Beyond Macro With the macro outlook for Japan remaining uncertain, there is also an argument being made that investors should steer away from top down analysis and instead approach invest- ments in the country through a bottom-up lens. And from that perspective, the picture looks a lot less gloomy. As an advocate of a bottom-up stock picking approach for Japan, Kim argues that global investors have too often focussed on “macro political hooks” to justify their investments, rather than attempting to better understand the nature of Japanese companies. He highlights that company valuations have become much more attractive. For example, shares have moved from trading at 30 times price-to-earnings ratio to 12 times. Moreover, share buybacks and dividend payments have more than doubled. Kim argues that in being distracted by the macro picture, many investors are overlooking these opportunities. McLellan also backs this view. “Ultimately, our approach is driven by bottom-up stock selection with an overlay on our top- down macro view which informs our positioning at the mar- gin,” he says. And from that perspective, Japanese stocks still offer opportunities. “Valuations remain attractive, balance sheets continue to be strong and are nicely positioned to weather a downturn. Because Japanese companies have been conservatively run, there is room for margin improvement. “Companies have the potential to improve margins and release some of that value, that is part of the long-term attraction of Japan rather than necessarily any standout macroeconomic issues,” he adds.
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