Asia’s interdependency a highlight of recent trip to region, explains Psigma’s Thomas Becket

Thomas Becket, CIO of Psigma, says Asia is balanced between the genuine long term recovery potential in Japan and the short term concerns over the strength of growth in China, but that either way these two key economies are increasingly interdependent.

Every day I remind myself how lucky I am to work in such an interesting industry. Regardless of the various burdens that come with the job and the stress that markets can cause, I can never argue that I’m bored by an ever-changing world. A combination of financial, political and economic events keeps me fully occupied. My trip last week to Asia allowed me to evaluate the opportunities in Japan and China, where the respective economies are diverging and the new leaders of both nations have a mighty challenge on their hands. Over the last twelve months there has been a massive revival in Japanese equities and totally abject performance from the Chinese stock market. I found it hard to believe, particularly after the last decade, that I left Heathrow far more worried about what I might find in China than in Japan.

Konichiwa from Tokyo

A fantastic but sweltering few days in Japan taught me that the economy is finally heating up in Japan. The recent market recovery since the May ‘mini-crash’ reflects an improving confidence at both a consumer and corporate level. Where once there was a sense of doom and depression, there is now hope. This is an amazing change. Previously, Japanese fund managers desperately tried to sell you their ever-shrinking funds on the basis of extremely cheap valuations; now they convincingly talk of a renewed sense of activity in the Japanese economy, long overdue reform and pent-up demand. Our conclusions were that we remain very bullish on the medium term outlook for Japanese equities.

The unified national effort to blast Japan from two decades of stagnation and (more recently) deflation is being led by the Abe administration and keenly supported by Abe-san’s main man, Kuroda-san, at the Bank of Japan. The first two arrows of their ‘three arrow’ strategy have hit the mark, as monetary policy and fiscal policy have been loosened aggressively, thereby weakening the yen to aid corporate competitiveness. The success of the third (long overdue and desperately needed) structural reform will determine the success or failure of “Abenomics”. Extraordinarily, for once we have confidence in a Japanese politician. The view on the ground in Tokyo was correctly that Abe-san and his allies would romp the Upper House election last month and therefore have a 3 year unopposed mandate for change. Sensible policies have already been mooted and will be a step in the right direction. Longer term, Abe-san might seek to change Japan’s post-war constitution, which was drafted long ago by the victorious Americans, and leave his indelible mark on Japanese history. To be in a position to do that, he will need a strong economy and high levels of confidence.

The economy itself is definitely starting to warm up, primarily led by consumption, but followed now by improving industrial production and manufacturing, despite softening globaldemand. Domestic companies, many of whose profitability has been boosted by the weak yen, have been tentatively adding to capital expenditure and are starting to boost wages, as Abe-san has demanded. Tax breaks on business investment should help this further. Importantly, confidence and cash has started to drip from Tokyo to other regions in Japan, broadening the economic revival.

Even after the 70% rally we have enjoyed from Japanese equities since last November, when Abe-san came to power, we don’t think it is too late to be looking for opportunities in Japan. From a valuation perspective it is hard to argue that Japanese companies are expensively valued and there remains the potential for a long term growth surprise, which is under appreciated by investors. Indeed, if Abe-san is successful in weakening the yen further then Japanese companies could still be very cheap. We also think that the high levels of scepticism from many global investors and under-ownership of Japanese equities could lengthen this rally substantially. Fund managers who have refused to consider investing in Japan on the understandable basis of two decades of barely interrupted pain are now feeling the heat of a market that has soared from the November lows and is up nearly 40% this year. There are obvious risks to the implementation strategy of Abenomics and it would be naïve to suggest otherwise, but we believe as great a risk could be resisting the temptation of owning a healthy weighting in Japanese equities.

Our current favourite picks are Jupiter Japan and we recently bought a position in Lazard Strategic Japanese Equity. It will be right to be flexible in your thinking to Japan, as markets will be volatile, but this presents opportunities. We moved tactically underweight Japan in late May, before buying back aggressively to overweight a few short weeks later in June, after a significant market correction.

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