Japan stock market and funds review – is it finally time to invest?

Japan, like many other countries around the world, has had a difficult start to the year. A number of challenges have thrown its recovery off course, leaving behind a trail of uncertainty. Lingering effects from the pandemic, reintroducing restrictions and rising inflation are just some of the factors putting pressure on the country’s economy.

The country’s economy experienced an uptick in the second quarter of this year though, boosted by an increase in consumer spending and a rebound in tourism. The economy bounced back to reach its pre-pandemic level.

In our latest Japan sector review, we take a deeper look at the challenges and the impact they’ve had on the economy. We also look at how the stock market’s reacted, as well as how some of our Wealth Shortlist Japanese funds have fared.

This article isn’t personal advice. If you're not sure if an investment is right for you, ask for financial advice.

What’s happening in the economy?

Earlier this year, the country was hit by another resurgence of coronavirus. It arrived this time in the form of the Omicron variant. In an effort to reduce infections, the government reinstated restrictions across the country, which included a ban on foreign visitors. This hampered Japan’s recovery efforts in the first quarter of this year.

The country is currently in a much better position than it was before the arrival of the Delta variant, as almost 80% of the population are now fully vaccinated. This meant the restrictions weren’t in place for long and were lifted towards the end of March this year.

This resulted in an increase in consumer spending and tourism, which aided Japan's GDP (gross domestic product) in the second quarter this year. While there’s still some concern that lifting restrictions will result in an increase in infections, the government recognises a balance must be struck between antivirus measures and supporting economic growth.

Just as Japan’s economy is regaining strength, economic growth among some of its key trading partners is slowing. The US and Europe are currently dealing with high inflation and recessionary pressures, while China maintains its zero Covid-19 policy which restricts trade. The conflicts in Ukraine and Taiwan continue to disrupt supplies and the yen has dropped to levels not seen in nearly 20 years.

This has resulted in a trade imbalance in Japan. China’s pandemic-related lockdowns, struggling property sector and slowing economy have harmed Japanese export demand. While the US and parts of Europe have fared better, demand is expected to dwindle because of the problems they’re currently experiencing.

Imports, on the other hand, have increased, partly due to the successful vaccination programme, but also because of Japan’s need for certain resources, like energy. A weakening yen has made these imports more expensive, but it could boost the attractiveness of Japanese exports in the long run.

Many expect Japan’s economic growth to stay positive for the rest of year, but will lag previous forecasts. A combination of these issues presents high hurdles to overcome. And then there’s inflation.

Inflation, is it good or bad for Japan?

Most other countries are experiencing spiralling inflation, for example the US and Europe are dealing with 8.5% and 8.9% respectively. Japan’s inflation rate is currently 2.6%. While this is a lower level in comparison, it’s historically high for Japan.

Japan went through a period known as the ‘Lost Decade’ from 1991 to 2001, during which it experienced years of slow growth and deflation. Deflation occurs when the prices of goods and services fall over time, meaning you can buy more tomorrow with the same money you have today.

While this sounds good in practice, it can cause problems. For example, people would rather save their money or keep it in cash, instead of spending it. This can hamper economic growth. One of the Bank of Japan’s (BoJ) objectives has been to increase inflation, thereby encouraging people to spend their money and reigniting the economy.

Inflation has now climbed above the bank’s 2% target, which is positive news. Companies have been able to pass on costs to consumers, resulting in a boost to the economy. But inflation is beginning to rise faster than wage increases, raising the possibility that the increase in consumer spending will be short lived.

Unlike other central banks around the world, the BoJ has no plans to raise interest rates or tighten its monetary policy to help control inflation. Instead, the governor of the BoJ believes that keeping interest rates low and providing adequate support is critical to allowing the economy to function well.

If inflation continues to rise, and becomes unsustainable, Japan could be forced to follow other central banks’ lead. But for the time being, they’re not in that position.

How’s the stock market reacted?

The Japanese stock market saw some positive bursts of performance in 2021. We saw the Nikkei, an index comprised of the biggest 225 Japanese companies traded on the Tokyo Stock Exchange, reach levels not seen in over 30 years.

This hasn’t been the case over the last 12 months though. The Omicron variant delayed plans to reopen the economy, which sapped growth and consumer spending. Inflationary pressures are beginning to emerge and concerns about slowing growth from key trading partners are restricting Japan’s recovery efforts. As a result, the Japanese stock market fell 3.72% over the last 12 months.

One-year performance – Japanese stock market versus other global stock markets

Scroll across to see the full chart.

Past performance is not a guide to the future. Source: Lipper IM, to 31/ 08/2022.

That said, lots of Japanese companies have reported rising profits, buoyed by a rebound in tourism and consumer spending. Inflation is also helping the domestic market in the short term.

Japanese companies could also benefit from the Kishida government’s ongoing economic support. There are plenty of challenges ahead and market ups and downs are likely to continue. Over the long run, we’d expect the market to offer interesting investment opportunities.

Past performance is not a guide to the future. Source: Lipper IM, to 31/ 08/2022.

How have our Wealth Shortlist funds performed?

Japanese Wealth Shortlist funds delivered mixed performance over the year as different investment styles came in and out of favour. Funds investing in companies undergoing a turnaround, otherwise known as ‘value’ focused funds, did well. Those investing in companies capable of above-average earnings growth, also known as ‘growth’ funds, took a hit.

One year is a short period to assess the skills of a fund manager. Managers with different strengths, styles and areas of focus will perform differently over time.

Remember, all investments can fall as well as rise in value, so you could get back less than you invest. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Man GLG Japan CoreAlpha was the best performing fund in the Japan sector of the Wealth Shortlist. The fund returned 13.56%*, beating the broader Japanese stock market by 17.28%.

The fund sits at the deep value end of the spectrum and benefited as the style returned to favour with investors. Good stock-picking from manager Jeff Atherton, alongside strong performance in the industrials and basic materials sectors, also helped drive the fund’s performance.

Find out more about Man GLG Japan CoreAlpha, including charges

Man GLG Japan CoreAlpha Key Investor Information

On the other hand, the FSSA Japan Focus fund was weaker. It’s a much more growth-focused fund and has naturally struggled amid the value rally, falling 25.14%* over the last 12 months.

Manager Sophia Li doesn’t tend to invest as much in companies more closely linked to the economy, including financial and oil & gas companies. This means she missed out on some of the gains made. Instead, she continues to invest in high-quality companies capable of above-average growth over the long term.

More recently though, the fund has showed signs of recovery. Growth investing bounced back over the last two months and the fund returned 12.53%. Again, this is a very short period to judge performance though.

Find out more about FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information

We think these funds could dovetail well in a portfolio. One has the potential to do well when the other struggles. Investment styles can fall in and out of favour, but we think both funds have the potential to perform well over the long term. Past performance isn’t a guide to the future.

Past performance is not a guide to the future. Source: *Lipper IM, to 31/08/2022.

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