Tucked into an office above a Sainsbury’s Local in a quiet street in York, the GLG Japan Core Alpha team of fund managers ponder their investment strategies. From this unlikely location, they manage $6.5 billion — and speak with measured optimism about Japan. ‘Relative to other countries, Japan is probably one of the best places to be on a three- to five-year view,’ says Steve Harker, who runs the team.
Japan has suffered badly from a perception problem over the past 25 years. The disastrous decade from the late 1980s, when markets underperformed dramatically, has stuck in the minds of investors and encouraged them to regard Japan as an oddball market in terminal decline. ‘In reality the economy has performed almost the same as that of the US over the past 35 years,’ says Harker. ‘The corporate sector is in good shape. Society is as stable as it gets. Japan is a perfectly normal market, and it’s cheap in terms of dividends and price-earnings ratios. It’s been very cheap for 15 years and at some point I think Japan will normalise and deliver returns better than those of the US and the UK.’
Flying into Tokyo last month, I found the city centre exuding its usual air of order, efficiency and immaculate cleanliness. Gleaming high-rise hotels are under construction, a new 314mph underground magnetic levitation train line is being built to link the capital with Osaka, shaving an hour and 18 minutes off the current fastest service, and competition venues for the 2020 Olympics are already in carefully planned preparation. Business appears to be booming.
Clearly the weakening of the yen, through large amounts of quantitative easing, has played a vital role in making Japan’s exporters more competitive. ‘Prime Minister Abe’s plan is to nurture the corporate sector,’ says Rupert Middle, investment consultant at Tachibana Securities. ‘He’s planning to cut corporate tax, but he’s also had to commit to putting up the consumption tax again to 10 per cent from the current 8 per cent. The individual consumer is suffering but the corporate sector is benefitting. Companies like Fuji Heavy [aerospace and Subaru cars], Murata [electronic components] and Bridgestone [tyres] are posting record profits helped by a weaker yen — which is a feature of so-called “Abenomics”.’
‘The outlook for the stock market is bright. Profits are at a record high and set to go higher. Valuations are historically low. The market is trading on a p/e ratio of 15.5 times and a dividend yield of 1.8 per cent. Dividends are already at a record level. Return on equity has moved up to 9 per cent. I’d say the Japanese stock market is at its most attractive for investors since 1982.’
Middle reckons that Japan funds should do well over the next few years. ‘Investors should go for long-only funds, but consider hedging against a weaker yen. The Ruffer Japanese fund and City Financial’s Opportunities fund, for example, are both run by experienced managers with exposure to both large- and small-cap shares.’
There seem to be three big reasons to support expectations of a bull market for Japan, at least in the short term. The first is that policy action is coming to the fore. The recent weakness in domestic demand, caused by the consumption tax hike, has spurred policymakers into action. The Bank of Japan is expected to ease again, and fiscal policy should produce another supplementary budget worth about 1 per cent of GDP — good news, because it should drive shares higher. The second reason is that earnings momentum is improving and the anticipation and realisation of improved earnings is expected to drive shares higher again.
Finally, and perhaps most importantly, bank credit is expected to enter a new growth phase. ‘Over the past six months, bank credit has stagnated because business investment and mortgage credit expansion took a hit from the hike in consumption tax,’ says Jesper Koll, managing director and head of Japanese equity research at JPMorgan in Tokyo. ‘But now we’re seeing upward revisions from small and medium-sized companies on their business investment in Japan, and we’re seeing a continued firming of the Japanese labour market with more people being hired on a full-time basis, which should translate into a further up-cycle for the Japanese residential property market; all of which should lead to bank credit growth beginning to accelerate over the next three months. Banks have been big underperformers so far this year. They are very cheap, trading at about 0.6 times book value. If we get policy action and greater visibility of a bank credit cycle, then banks should be the first to benefit.’
Steve Harker at GLG notes that Japan’s major banks have declined in number from 19 in 1989 to just seven today following a series of bankruptcies, nationalisations and mergers. The decline in lending and earnings which caused the dramatic shrinkage of this sector is now reversing and banks are slowly becoming more profitable. This also indicates that, if business and consumers are borrowing more, then the whole economy is beginning to expand and should, eventually, generate real inflation.
Alex Kinmont, chief executive of Milestone Asset Management in Tokyo, says there are a lot of cheap stocks around. ‘In terms of pure value, something like 475 to 500 of the 3,800 stocks that are listed are at first glance very cheap compared with earnings power. The genuine value seems to be found at the small end of the market [in terms of capitalisation] and at the very large end. So companies with market caps of less than a billion yen or more than 10 billion yen are looking cheap, but the ones in the middle are not.’
Kinmont speaks highly of GLG’s Japan Core Alpha fund, and also of Japan funds run by Baillie Gifford. ‘They’re a class outfit,’ he says. ‘They pay a reasonable price for growth stocks and they do very well.’