Invesco’s Chesson gives positive outlook of Japanese equities
Paul Chesson, head of Japanese Equities at Invesco Perpetual, answers a Q&A on the Japanese equity market and outlook for the economy.
Could you give us your views on the outlook for the currency?
We always remain conservative in our projections about currencies, because I think they are, almost by definition, impossible to forecast. You have to deal with probabilities. For a number of years, our view has been that the yen was too high based on the likely directions of monetary policy in the most important currency that the yen is crossed with; i.e. the US dollar. We always had the view that it was likely that monetary policy would normalise in the United States sooner than was the case in Japan. That view has been slightly overtaken by the fact that monetary policy has, of course, ended up being much looser in Japan than I or most people expected, which has exaggerated the impact. It is very difficult to know exactly what impact it is going to have on the dollar-yen rate over the next 12 months. The least you can say is, arguably, what I have already said in my preamble, which is that, whether tapering starts this month, or is still six months or even longer away than that, the fact is that the United States is moving towards that scenario through a period of time when Japan is much further away from it and, in fact, going in the opposite direction. It seems very unlikely to me, then, that the yen will be particularly strong.
Whether it will be excessively weak from here as a result of this is very difficult to know because, if we did start to see a much weaker move, at some point I think we have to expect some political pressure that things have gone too far. It is not really in anyone’s interests – neither Japan’s nor that of the rest of the world – to see the yen lose a very dramatic amount of its value against other currencies over a short period of time. The move that we have seen so far has, perhaps, been accepted by the internationally community because it has been seen as a correction of an overvaluation. Perhaps this kind of level would seem fair. If we see excessive weakness from here in the short term, the international community would perhaps feel less comfortable. We have to see that as possibly being a check and balance against any excessive weakness in the market from here, but one thing that you can be sure of is that Mr Bernanke is not going to be put off his approach towards a prudent monetary policy in the United States, and Mr Kuroda is not, for the time being – at least well into 2014, with the fiscal drag next year – going to be put off his aim of pursuing aggressive monetary policy to try to end some of the forces of deflation. That is not a recipe for a currency that strengthens, so we should expect to see the yen under downward pressure. It is difficult to know how much, but the downward level will be moderated by political perceptions about how far it should go. We should not expect excessive weakness but we should perhaps expect a more gradual undermining over a period of time into 2014. That might seem like a vague answer but it is the best we can do when we are talking about these sorts of things. I hope that that gives you an idea of what direction we should expect and the various factors that are relevant to that.
Should we be concerned about the rising nationalism in Japan and the resulting tensions that that might cause with China?
I do not think the issue of tensions between China and Japan are going to go away. They have been under the surface for quite a long time now, going back to the spat about the history books in the last decade and, of course, more latterly, about the islands that are in dispute. These things are going to come up from time to time and we should live with that. Just as last year’s spat had nothing more than a short-term economic impact, I do not expect it to have more than that when it does arise. That has certainly been the history of this problem and I do not see why it should be any different in the future. You could say that China is trying to rebalance its economy. Part of that is to encourage inward investment.
Japan is a very important inward investor into China and that is going to remain the case. Japan needs Chinese markets for its goods; China needs Japanese technology and that inward investment. There is, then, a symbiotic relationship between the two. While even China runs an open economy from this point of view, these two countries are unlikely to do anything extreme, at least within reasonably foreseeable scenarios, to undermine that. Both countries are interested in the benefits of this relationship. We are going to see diplomatic spats from time to time, which will have a short-term economic impact, but the idea that it is going to really undermine the medium-to-long-term outlook for the relationship or the individual growth rates of those two countries seems to be an extreme view and rather unlikely.
Is Japan still a good opportunity over the next two years?
My main point that I would like to draw out is that, although we have seen this move in the market, we have not seen an upward rating of earnings valuations, notwithstanding the improvement in the outlook. It is, then, a great opportunity today from that point of view; how and when it plays out is always the more difficult question. The question specifically mentions ‘over the next two years’, but that really depends on when the returns come. If Japan does what it has done in the past, where the equity gains tend to come over relatively short periods of time, it is not impossible to imagine a very strong market and that, within a shorter period of time than two years, we could be looking at a market that is beginning to rerate upwards and we need to start to become not necessarily cautious, but certainly more modest in our expectations of upward movement. Whether it plays out over two years, I do not know, but I think the most important thing is that, from here, it looks attractive to me from a growth and valuation point of view.
Does demographics in Japan also present investment opportunities such as in healthcare stocks?
It is a threat to growth, and certainly the bottoming out of the birth rate in Japan has not been enough to undermine the negative impact of an ageing population that is not growing in total. As far as healthcare stocks are concerned, it is quite difficult to turn that into an investment case, certainly for medium- and large-size companies, partly because, apart from the pharmaceutical companies, it is difficult to find a pure way of playing that idea, and partly because the government is still shouldering a lot of this burden. We know what Japan’s government debt is like. Clearly, the pressures on those budgets are not going to go away as the population ages. At the margin, then, it is hard to see how there is going to be greater largesse for companies outside the pharmaceutical area whose revenues are, ultimately, going to be influenced, to some extent, by government subsidies.
Within the pharmaceutical area, most of the big companies have made their successes overseas. Half the revenues of Japan’s largest pharmaceutical company are overseas, so, arguably, the domestic angle is not really a big driver for growth. Many of the growth areas – i.e. lifestyle-related drugs – have already reached their potential; things like diabetes and those sorts of problems. Just as pharmaceutical companies in the rest of the world are struggling to find a pipeline of blockbuster, inhouse- developed drugs, the Japanese pharmaceutical industry is no different.
In terms of valuation, even though Japanese pharmaceutical companies are not sensitive to the economic improvement that we are seeing at the moment, their growth is more stable over time, because of the nature of their business. You are not paying for this more modest growth outlook, and you are not paying a lower price for it, so, from a valuation point of view, it is very difficult for us to make an investment case.
While, in theory, then, it would be nice to think that we could make a good growth argument in equity terms for the idea of an ageing population, it has been very difficult to do for quite a long time already, and it certainly is not getting any easier as time goes on. That is not to say that some of the companies in our portfolio do not have businesses that are not related to medical spending, but we are certainly not invested in or looking at any companies at the moment where that is the majority of their business.
Will quantitative easing in Japan help to offset US tapering?
If this question means whether monetary easing in Japan will offset the negative impact of US tapering on emerging countries, I suppose the simple answer is that I do not know. I am not sure that anybody has tried to quantify the impact but, generally speaking, I would say that it is unlikely, given that, generally, Japanese money tends not to flow overseas. While Mr Kuroda is keeping a lid on bond prices, there is no aggressive disincentive for Japanese individuals to completely kick their bond habit. That may come, but I think, in the meantime, the simple answer is that, for the rest of the world, Japanese monetary-policy looseness is not going to offset monetary tightness in the United States.
In terms of the impact on growth globally, the fact that the US economy is so much more dynamic than Japan and will achieve higher rates of growth, and probably higher rates of inflation, under most monetary circumstances, means that Japan is unlikely to take up the growth-engine mantle of the rest of the world. From that point of view, we should be quite cautious about what we think monetary looseness in Japan is going to mean for Japanese growth or global growth. The simple answer to the question, then, is that I do not think it is going to offset the impact of tapering for the rest of the world, but, from a growth point of view, we do not necessarily need to worry about that, particularly because Mr Bernanke has already been very careful to state that he is going to be slow to put on the brakes, and he will not do anything to undermine the gradual improvement in the US economy, which, we must not forget, is still the world’s largest economy.