Japan outlook: Still positive despite correction – Invesco’s Chesson comments
Paul Chesson, head of Japanese equities at Invesco Perpetual, explains the team’s continued positive view on the potential for Japanese equities.
The Japanese equity market has experienced a weak start to 2014, a trend shared by most global equity markets so far this year. Following a sharp fall of 4.8% for the Topix index yesterday (04 February), the year to date decline has now reached 12.5%.
While there are a number of short term influences that have contributed to the market’s recent weakness, including a strengthening of the yen, general concerns about the impact of QE tapering by the US Federal Reserve and volatility in some emerging market currencies and equity markets, our reasons for being positive on the outlook for Japanese equities remain in place. It is also worth remembering that these declines have come after a sustained period of strong performance for Japanese stocks, which saw the Topix index gain 51.5% in local currency terms in 2013.
Valuation is our primary focus and at the start of the year the Topix was trading at around 15x consensus earnings to the end of the fiscal year in March 2014. This was roughly in line with other developed markets and with corporate profits in Japan growing more quickly than for their developed market peers we considered this valuation level to be attractive.
The fiscal third quarter earnings season is currently in progress and in aggregate profits are broadly in line with expectations. Based on data from Mitsubishi, sales are forecast to increase almost 10% and pre-tax profits by around 30% and yet following the recent market falls the Topix is now trading at 13.7x for 3/14 and 12.5x estimates for 3/15, levels that we believe are attractive. We are also able to find a number of opportunities in stocks that are trading on significant discounts to market valuations.
The yen has strengthened from over Y105 to the dollar to just over Y101 currently, but it is still a long way from the mid-70’s level of just two years ago and at around the Y100 level it is largely in line with many company forecasts. While there will be short-term fluctuations, we believe that the yen should remain weak against the US dollar.
The US Federal Reserve is likely to continue to gradually remove stimulus over the course of this year while the Bank of Japan’s bias is expected to remain tilted towards more easing. In addition to its influence on the Japanese currency, Fed tapering has positive implications for the Japanese economy as it is a sign that the underlying health of the US economy continues to strengthen.
Japan’s central bank and the government are also expected to remain supportive of the domestic economy as the consumption tax rises in April of this year. This tax increase is expected to result in strong GDP growth in the first quarter of the calendar year as consumers bring forward purchases and then a sharp decline is likely in the second quarter as consumption temporarily stalls. We believe that GDP growth will then begin to improve again and in our view downside risks to growth should be limited by stimulus from policymakers later in the year if the economy’s performance is weaker than currently anticipated.
Japanese markets have been weak in 2014 so far, but we believe that valuations are attractive, the economic backdrop in Japan and overseas should be broadly supportive, and earnings growth remains robust. As such, we continue to have a positive view on the potential for Japanese equities.