Nicholas Price, portfolio manager of Fidelity Japan Trust, discusses why he maintains a positive outlook for Japanese stocks as we head into 2022.
Opportunities abound in attractively valued Japan
We remain broadly positive on the outlook for the Japanese market as we move into 2022. Valuations remain supportive and compare favourably with those in other developed markets such as the US, while earnings momentum is strong.
A delayed recovery in the manufacturing sector due to Covid-19 restrictions and supply disruptions means that some of the earnings recovery has been pushed into the first half of 2022. While there was some weakness in the first half of fiscal 2021, we expect corporate profits to be quite strong in the first six months or so of next year. The outlook for the second half of 2022 is less clear with the potential for interest rate rises, so we are looking at B2B companies and moving away from consumer-related names and those that have benefited from strong pricing this year.
What could surprise markets in 2022?
In terms of positives, as recent headwinds to earnings, notably supply constraints, raw material costs and freight rates, fall away and start to reverse, we could see a decent uplift to earnings in the first half of 2022. On the other hand, a potential negative would be high and rising energy prices leading to an economic slowdown globally.
Positioning for what lies ahead in 2022
As supply constraints ease, consumer-related companies will see a peaking-out in margins and as we move towards the second half of 2022, a lot of the pent-up demand will have played out. Against this backdrop, we are looking at long-term winners that can grow sustainably. This includes companies with strong positions in growing markets such as factory automation and software services, those with new product cycles, and those implementing ESG-related and structural changes.
In particular, we like companies that are efficiency enablers in both the manufacturing (factory automation) and software (digitalisation, SaaS) sectors. Over the longer-term, we are looking at companies that can contribute to and support Japan’s energy transition and the requirements for energy efficiency such as green energy, factory automation and EV components.
At the same time, a gradual loosening of supply bottlenecks means that the pricing environment will become less favourable for many companies. As products become more widely available, pricing will shift downwards. As a result, we favour companies that are not directly consumer facing and avoiding manufacturers that may face pricing pressures as supply constraints ease.
High conviction ideas tend to be where we have a differentiated view versus the market in terms of a company’s mid-term growth prospects. The largest overweight positions in the fund are companies that are efficiency enablers that can generate growth. On the other hand, financials in Japan continue to face structural headwinds and we are generally underweight in that area of the market. We are also avoiding companies that benefited from short-term bottlenecks and those with sluggish mid-term growth prospects.
Sustainability is core part of the Fidelity-wide investment process. Assessing which companies can grow sustainably over the mid-term and enhance the efficiency of other corporates and their supply chains is a key part of my portfolio construction. By working closely with our Head of Engagement in Tokyo and maintaining an active dialogue with investee companies, we aim to continually improve the sustainability of their businesses, which will also enhance their performance as investments.
Globally, the uncertainty wrought by Covid-19 has shone a light on sustainability and Japan is no exception. Although Japanese companies generally have lower sustainability scores than their European counterparts, we believe this is not due to any fundamental differences in strategy - but more to do with cultural reasons around disclosure practices and language.
By working closely with our Sustainable Investing Team on the ground in Japan, we are able to identify companies that are implementing real change and moving up the governance scale. As these companies improve disclosure, ESG ratings should catch up and the market should adjust valuations accordingly. For investors, this creates an opportunity to benefit from the adjustment.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity Japan Trust PLC invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. Changes in currency exchange rates may affect the value of investments in overseas markets. The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. This investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility.
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