Outlook is bright for Japan

Key points

• Pent-up demand among both consumers and businesses will continue to underpin growth, and we have started to see a pickup in the number of inbound tourists taking advantage of the weak yen.
• While we continue to find a lot of ideas among mid/small caps, we are also seeing attractive opportunities is in the unlisted sector.
• By working closely with our sustainable investing team and maintaining an active dialogue with investee companies, we aim to continually improve the sustainability of their businesses, which should also enhance their performance as investments.

With the global economic outlook darkening, Japan is an outlier - showing a degree of resilience as Covid-19 restrictions ease and the economy finally reopens. Unlike many other countries, the economic policies of the Japanese government and central bank are a positive mix of fiscal expansion and monetary easing.

According to global forecasts by the International Monetary Fund (IMF), Japan’s economy will be one of the few to see growth accelerate this year and maintain nearly the same pace next year. After keeping its borders closed to most travellers throughout the pandemic, Japan has begun reopening. Pent-up demand among both consumers and businesses will continue to underpin growth, and we have started to see a pickup in the number of inbound tourists taking advantage of the weak yen.

Finally, valuations are close to the Global Financial Crisis (GFC) trough and the resilience of corporate balance sheets in Japan means that its exposure to the rising cost of debt globally is limited and buybacks and dividends are set for record highs.

What could surprise markets in 2023?

Inflation surprises have driven market expectations for the pace of Fed rate hikes. As economic activity weakens, however, bond yields are likely to be restrained by lower levels of growth. If the view that long-term rates have peaked gains traction, this would help to put a floor under equity markets. It would also support a bottoming out in growth stocks, and I would expect some of the names that performed poorly in 2022 to come back quite strongly.

There is also the potential for beaten-up technology stocks to start performing again, especially as earnings disappointments are coming out as we approach the trough of the cycle. Meanwhile, Bank of Japan Governor Haruhiko Kuroda’s term will end in the spring and speculation over the future direction of monetary policy in Japan is set to intensify. It’s not yet clear who will succeed him, but it remains to be seen how much longer the Bank of Japan can continue with its existing policy.

Positioning for what lies ahead in 2023

While we continue to find a lot of ideas among mid/small caps, we are also seeing attractive opportunities is in the unlisted sector. New listings (both in Japan and globally) are coming under pressure amid heightened geopolitical and inflationary risks, but new growth companies are still coming through, which will create future opportunities in the pre-initial public offering (IPO) market.

While Japan has always been successful in automobiles and electronics, the information revolution is throwing up new opportunities in areas such as software as a service (SaaS). We are also seeing new business opportunities emerge in response to major challenges facing the world, primarily climate change and decarbonisation. For example, one of our pre-IPO companies, fintech innovator Moneytree, recently announced a tie-up with Cogo of New Zealand to provide carbon emissions analysis for Japanese financial institutions.

As Japan aims to reduce greenhouse gas emissions to net zero by 2050, there is accelerating demand for such carbon footprint management solutions. In terms of risks, the weak yen has been driving an earnings upgrade cycle though the sustainability is uncertain and a severe slowdown in global growth would have negative implications for exporters/cyclical elements of the market.

Looking ahead, we are focusing on domestic reopening names and consistent growers. We are also starting to see some emerging opportunities in China-related names and among oversold cyclicals that have already priced in a sharp decline in the US PMI.

Sustainability considerations

Sustainability is a core part of the Fidelity-wide investment process and assessing which companies can grow sustainably over the midterm 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 should 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.

Important information

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. 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. 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. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.

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