Driving assessment

What momentum is driving Japanese equities this year?

The weak yen, low interest rates and relatively low inflation clearly set Japan apart from its developed-market peers, says Mitesh Patel, Japanese equity manager at Jupiter Asset Management.

He points out that although the start of the year has been difficult for Japanese equity investors – especially international investors for whom the weakness of the yen has been a strong headwind – in local currency terms, the Japanese market has performed closer to, and in some cases better than, its developed market counterparts.

As for how Japan differs from said peer group, Patel explains that the currency’s weakness was caused in part by the monetary policy of the Bank of Japan (BOJ), which kept interest rates low at a when other major central banks have already raised rates and signaled further hikes to come.

“The widening interest rate differential has undermined the yen in the currency markets, but to some extent the BoJ’s actions are understandable – after all, unlike much of the rest of the world, inflation in Japan remains subdued at 1.2%.”

This compares to 8.5% in the US, 7.4% in the Eurozone and 7% in the UK.

Inflation, however, is on a steady upward trend in Japan, Patel says, exacerbated by higher energy costs, as Japan relies on imports for the majority of its energy needs. But in Japan, long-standing deflationary factors are also at play.

A weaker yen

“The weak yen increases costs for companies importing dollar-denominated materials from overseas, but Japanese companies are well positioned to absorb these costs as company profitability is stronger than it has been. never been.”

And Patel argues that in many ways higher inflation would be a boon to the Japanese economy – after all, they’ve been trying to boost inflation for decades now with little success. But he hopes preferably that it will not be “cost-driven” inflation driven by rising material prices or a function of the weakening yen, but rather induced inflation. by demand triggered by higher wages.

“Wages in the Japanese labor market are moribund, despite the country’s demographic situation, which means that the job market is extremely tight.”

Tomoo Kinoshita, global market strategist at Invesco, agrees that the depreciation of the yen should have a positive effect on the Japanese economy, but fears that if the yen depreciates too quickly, the future outlook for businesses and consumers could become blurry.

Schroders makes a similar assessment when it comes to levels of uncertainty right now. He remains neutral as the Japanese market is somewhat removed from the conflict in Europe but says the effect of imported inflation remains a threat.

Japanese market in 2022

This year, the performance of the Japanese market, like other markets, has been led by anything positioned to benefit from rising commodity or energy prices – e.g. mining, oil, energy – but are these sectors the way forward?

Not according to Patel: “We fundamentally view these sectors as unattractive because we don’t see them generating shareholder value through the cycle.”

“Our preference remains for dividend-paying stocks in less cyclical sectors, as well as quality growth companies where their long-term opportunities remain intact even when they face short-term headwinds and a shrinking the valuation of their shares.

Preferred Funds

Josef Licsauer, investment analyst at Hargreaves Lansdown, picks out two favorite funds. First, it checks the name of the Man GLG Japan Core Alpha fund.

“The managers invest in large Japanese companies, mainly present in the Topix. They invest in companies that they believe can be bought at a discount to their true value and sell them when they believe that the company and the stock price have recovered. This process currently leads them to invest in more economically sensitive – or cyclical – sectors of the market such as banking and insurance.

Second, he chooses the FSSA Japan Focus fund. This fund invests in companies that are dominant in their sector and appear mainly in the Topix.

“Managers seek to own faster-growing companies and believe that the strength and quality of the companies they own are what drive long-term returns.”

Licsauer adds, “More than two-thirds of the fund is currently invested in technology, industrial and healthcare companies. This can change over time, depending on where managers find what they think are the best opportunities. »

He suggests that these funds could fit well into a broader investment portfolio, as each focuses on growth or value investing.

“This means they may behave differently from each other in different market environments and when different investment styles are liked or not, although we believe both funds have the potential to perform well over the long term.”