After two lost decades, has Japan found itself?AdvantageVoice® Blog—
International investors have made a habit of maintaining an underweight to Japan over the past 20 years, resulting in an allocation of research and resources to other countries and away from Japan. What happens to the international investing landscape and investors’ portfolios if Japan escapes its doldrums? Have portfolio managers become too comfortable ignoring Japanese stocks? Not only have foreign investors abandoned Japanese equities, so have the locals. Japanese household exposure to Japanese equities is among the lowest in the world as a percentage of household assets, according to the Organisation for Economic Co-operation and Development.
Japan has been in the grip of deflation since its stock market peaked in 1989. Resistance to structural economic, political, and policy reforms, coupled with a rapidly aging workforce, has been the norm in Japan. Political gridlock, except for a brief period of hope in 2003–2005, has resulted in lost decades in an economic sense for Japan. For many, it is tempting to believe this negative cycle and psychology will never change unless the seeds of change clearly poke through the frozen ground.
Early signs of change are always tenuous, easily dismissed, and often easy to miss. Over the past 24 years, there have been few periods of hope and mostly only brief rallies in Japanese equities following points of utter despair. Perhaps this current period will be like all the others. It is indeed dangerous to think that it could be different, but thinking differently from the crowd often uncovers the most profitable investment opportunities, especially when the consensus knows you’re wrong.
In Japan today, the market is waking up to some important changes:
- High-quality, cheap companies
- The potential for real fundamental policy changes that could lead to important reforms
We have seen a series of events that give reform the best chance in decades. In December 2012, we were impressed by Shinzo Abe’s super-majority parliamentary win on a reform-minded and explicitly reflationary platform: policies that weaken the yen and his conviction to appoint a decisive new Bank of Japan governor and two deputies. These stances inspired market confidence in his reform agenda, and the yen has reacted accordingly with a 15% decline versus the U.S. dollar. Flows into Japanese equities have exceeded the pace of inflows during the pre-Fukushima surge and are approaching levels last seen in 2005, when former Prime Minister Junichiro Koizumi’s landslide victory triggered a 50% boost to the local equity market.
Abe’s assembled economic and finance A-Team (Abe/Amiro/Aso) has already provided a number of initiatives that form a welcome first-half 2013 backdrop to equities:
- Recovery spending (January’s announced ¥10Tr budget stimulus)
- Tax breaks and gift exemptions on sleeping assets (businesses and elderly have among the largest financial asset cash allocations in developed markets, 56% of $17Tr in household assets)
- Enhanced Ministry of Finance equity market participation (direct real estate investment trusts and equity purchases)
- Prospects for transformational Bank of Japan change (doubling of inflation target to 2%, 3% nominal growth, bond purchases in excess of expected issuances, including European Union sovereigns)
Both the equity market and the currency have responded favorably to these policy moves. With Abe’s government holding a 71% approval rating in Japan, we fully expect the favorable policies to continue to emanate from Abe and his team of advisors as they build support for their agenda at home and across the international community. As for identifying profit opportunities in the market, we recall that in the last notable rally in the Nikkei, 2005–2007, the best-performing strategy was a value-oriented one, buying the sectors that were most below their historical valuations at the beginning of the rally. Buying undervalued opportunities is one of the cornerstones of our investment approach and likely to be well rewarded by a continued rally in the Nikkei. As for the recent improvement in the Nikkei as the yen has weakened, the recent rally still pales by comparison to past Nikkei rallies, both in duration and magnitude. Moreover, as discussed above, we contend that more favorable structural change underpins this rally than almost any of the previous rallies.
Source: Strategas Research Partners
Past performance is no guarantee of future results.
We continue to monitor the politics and policies of the Abe government to measure its reflation resolve and to gauge the global response. In addition to watching the Japanese and global macro events during this early change, we are also listening to the companies we research on a bottom-up basis to understand the impact of Abe's agenda on the Japanese economy, the competitiveness of Japanese companies, and their longer-term earnings prospects and strategies. Investors need to rethink Japan carefully. Dismissing recent policies and structural changes could lead to the missing of a meaningful profit opportunity.
The views expressed are as of 2-19-13 and are those of Jeffrey Everett and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.