Global investors have cut Japanese equity exposures in recent years but that process is changing. The country's strong industrial base puts it in a good place to tap into economic recovery post-COVID-19. Japanese markets are also relatively cheap versus other developed markets, this firm says.
The following commentary about the investment and economic outlook for Japan, coming at a time of political change in the Asian nation, comes from Matthews Asia, the investment house. The views come from portfolio manager Shuntaro Takeuchi.
The impact of a new administration
Overall, the economic effects are neutral. On the positive side, Prime Minister Suga was a long-standing cabinet member under former Prime Minister Shinzo Abe, so the continuity of Abenomics policy remains intact. Due to COVID-19, the Japanese government has been more willing to expand its balance sheet. The Bank of Japan has remained in an accommodative monetary policy stance since 2013, and now fiscal policy is changing after having been characterised by austerity in recent years. The supplemental budget from the new administration is likely to be one of the world’s largest in terms of percentage of GDP.
On the negative side, Suga’s approval rating has declined faster than I initially expected, partly due to an increase in COVID-19 cases at year-end 2020. While Japan is managing the pandemic better in our view than many other countries, domestic media are criticising Suga as being late to introduce a state of emergency.
What’s driving Japan’s equity markets?
First, Japanese equities may be poised to benefit from a global recovery due to their exposure to global industrial production. More than 50 per cent of the MSCI Japan Index is in three sectors: industrials, information technology and consumer discretionary, which includes automotive companies. These sectors tend to do well when economic growth bottoms out then starts to improve. As we see in the JP Morgan Global Manufacturing PMI (purchase manager index) numbers, activity bottomed in April 2020 at 39.6 and recovered above 50 in July 2020. Japanese equity multiples expanded during this period.
Second, despite the multiple expansion, Japanese markets are still trading at discounted valuations compared with other developed markets. The price-to-book ratio of the MSCI Japan Index fell below 1.0x in March 2020, and, even with the recovery in the second half of 2020, it is now approximately 1.5x. By comparison, the MSCI Europe Index is currently trading at 1.97x and the MSCI Asia ex-Japan Index at 2.26x, with the S&P 500 Index at 3.97x.
Third, global investor flow is coming back to Japan. Despite excitement over Abenomics, global investors have been continually reducing Japanese equity exposures in recent years. In the last few months, however, this trend has started to reverse.