The Japanese market has enjoyed a strong run recently, following the re-election of the Liberal Democratic Party's Shinzo Abe as Prime Minister. Abe's promises of urgent economic action have been readily welcomed by the market. The proposed economic strategy is built on three pillars: flexible fiscal policy, bold monetary policy and raising Japan's growth rate. Has Japan finally arrived at a significant turning point?
Japan has struggled with a stagnating economy and deflation for over two decades following its spectacular stock and property market crash in the early 1990s. The Nikkei 225 index peaked just below 39,000 in 1989, but stands around the 10,500 mark today. However, it has gained 7% over the last two months*, indicating a new found optimism over Japan's economic prospects.
Expectations for the incoming government are high. As well as stimulating the economy, the new policies are aimed at meeting inflation targets and weakening the yen to make Japanese exports more competitive. It is hoped the Bank of Japan's asset purchase programme (quantitative easing) will combat deflation. Last year it announced an increase of ¥10 trillion to ¥101 trillion. By adding to bank reserves and reducing the cost of lending, further easing could prompt more money to flow throughout the economy and boost growth. This move by the central bank could also encourage consumer price growth and ultimately drive inflation higher.
These measures could also provide support in weakening the yen. Japan is heavily dependent on exports for generating economic growth, but a strong currency makes exports more expensive for overseas buyers. A weaker yen could be a positive for Japanese equity markets due to the large number of exporters represented in its indices.
Introducing such policies could also have adverse effects and Shinzo Abe has not been handed an easy task. If inflation rises, businesses will have to keep pace in terms of wage growth, which could ultimately hurt their competitiveness. Furthermore, a depreciating yen could make Japanese imports more expensive – a problem exacerbated by the closure of Japan's nuclear reactors following the Fukushima disaster, which means extra energy imports are necessary.
It will not be easy to fix Japan's fragile economy nor to repay its extremely high levels of debt. However, in our view, its stock market still looks good value and could have much further to run. Despite its problems, the market consists of many successful global companies and offers industry-leading businesses in fields such as car manufacture and factory automation.
One of our favourite ways to gain exposure to the Japanese market is through the GLG Japan CoreAlpha Fund. Manager Stephen Harker is a contrarian investor, seeking out-of-favour companies which could fare better if the economy strengthens. It is a concentrated portfolio of around 40 stocks, which allow each to have a significant impact on performance, but is higher risk. He favours some of Japan's largest companies, particularly those with a low 'price-to-book' ratio which measures how close a firm trades to the value of its underlying assets. A ratio of less than one means a company is valued at less than its assets and therefore might be considered cheap or good value.
It is this type of company that Stephen Harker believes has the greatest potential to perform well if Japan can continue to improve its financial situation. Exposure to his favoured sectors, banks and electric appliances, has benefited recent performance. Strong performance could continue over the long term if the government can deliver on its promises.
Japan remains a high-risk area for investment, but we believe sophisticated investors willing to take a chance on this unloved market could be rewarded over the long term. For further information on the GLG Japan CoreAlpha Fund and our favoured funds in the sector, investors may wish to take a closer look at the Wealth 150.
*Source: Lipper. Figures to 22/01/2013
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