Japan could offer an Olympic-sized opportunity as the undervalued market rides the coat-tails of the global economic recovery.
All eyes are turned to Japan this summer as it finally hosts the postponed 2020 Tokyo Olympics. The start of the games – which have only ever been cancelled during wartime in 1916, 1940 and 1944 – will allow the Japanese market to breathe a sigh of relief.
Japanese stocks have been hampered by the threat of another delay to the event, which sees more than 10,000 athletes compete in 35 different sports, as well as the slow roll-out of Covid-19 vaccines in Japan.
Citywire A-rated Daisuke Nomoto, manager of the £867m Threadneedle Japan fund, said while Japan has underperformed its global peers year-to-date, ‘we can expect this gap to narrow as the domestic vaccine roll-out gathers momentum’.
He said there was a positive correlation between vaccinations and equity market returns and Japan’s vaccination rate has now exceeded the 10% mark, which should help its stock market should catch up with the US and Europe.
‘If the vaccination progresses in line with the government targets of one million doses per day, Japan should be able to achieve herd immunity later this year – which may be priced into the equity market sooner rather than later,’ said Nomoto, whose fund has outperformed the average manager in his Investment Association Japan sector over one, three, five and 10 years.
Over three years, the fund has returned 8.5% against 4.1% for the average peer.
Nomoto said Japan will be a ‘key beneficiary of global recovery’ as it has a high ‘sensitivity’ to the global economic cycle and will be supported by a ‘synchronised global recovery’ this year. He also expects that ‘domestic corporate earnings growth will rebound’.
‘Over 50% of the MSCI Japan index falls under three sectors: industrials; information technology; and automotive-heavy consumer discretionary,’ he said.
The heavy weighting to these areas will drive returns when global growth improves and from a style perspective, Japan has a ‘weight of value stocks’, with almost double the number of value stocks compared to the global market.
‘We can therefore expect the current environment to provide investors with an attractive risk-reward trade off,’ said Nomoto.
In a note on the £152m closed-ended AVI Japan Opportunities (AJOT ), Quoted Data analyst James Carthew said the value opportunity in the Japanese market looked ‘considerable’.
He said smaller companies – which make up the AJOT portfolio – have lagged ‘by an even greater margin’ despite ‘strong earnings growth and resilient cash generation’, meaning the ‘opportunity is considerable’.
‘There are almost 3,800 listed stocks in Japan. AJOT believes a significant number of these are mispriced by virtue of their inefficient balance sheets and holdings of surplus cash or listed securities in particular,’ said Carthew.
AJOT’s returns remain towards the top end of its peer group for this year after a tougher 2020. Over the past 12 months the fund has grown its net asset value (NAV) by 9%, while the share price total return has been 10.3%.
Hardman & Co analyst Mark Thomas flagged the performance of Fidelity Japanese (FJV ), which has beaten both closed and open-ended peers as well as the Japanese market over five years.
The £287m fund has almost doubled its NAV in five years, up 98.3%, against a 49.4% return from the Topix index, which tracks the First Section of the Tokyo stock exchange.
Thomas said the outlook for Japan looks positive thanks to growth in the US, its key trading partner, while more domestically, ‘Japanese balance sheets are strong, allowing returns to investors and increased economic activity’.
‘Japan’s population is relatively affluent, with plenty of catch-up potential as the economy reopens, and its market valuations are undemanding,’ he said.
Columbia Threadneedle’s Nomoto said Japan remains an ‘overlooked’ region, partly due to ‘lacklustre economic growth’ as well as the challenges brought about by its ageing population.
However, he said there is a ‘deep investment universe of high-quality companies that generate sustainable earnings growth’, as well as long-term structural opportunities in automation and robotics, where Japan is a global leader.
‘We expect a global ageing demographic to support trends in automation, remoteness and digitalisation of social infrastructure,’ he said, adding that companies such as sensor manufacturer Keyence, robotics group Fanuc, and motion controller and industrial robot manufacturer Yaskawa.
While it may be a leader in robotics, Japan has lagged western economies in the adoption of cloud technology and digitalisation, but a ‘software revolution’ is underway, said Nomoto.
‘The adoption of such technology can help transform Japan’s economic and corporate landscape for the better, helping to alleviate labour shortages, boost productivity and economic growth, while also improving corporate competitiveness and profitability,’ he said.
He is playing this trend via companies such as Z Holdings, which owns Yahoo in Japan, cloud payroll group Freee and GMO Payment Gateway all benefiting.
The third theme, Nomoto is playing is consumer brands, as Japanese companies have a ‘vast market on their doorstep with strong demand across Asia’.
He has invested in car maker Toyota, electrical goods giant Sony, and make-up and beauty brand Shiseido.
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