We appraise Japan, along with other world markets, in a quantified framework that integrates top-down views along with bottom-up stock valuation. For Japan, the individual stock forecasts are the principal determinant of weightings in the market. Currently our global portfolios are underweighted in Japanese stocks relative to their benchmarks, although we have had above-benchmark weights in the past.
A clear effect of monetary and fiscal policy in Japan has been a weakening yen since Prime Minister Abe was elected in December 2012, subsequently pursuing policies that are referred to as Abenomics. The yen has weakened below last year’s low, while the capitalisation-weighted Japanese equity market is still below last year’s peak. Investors have been disappointed so far with the lack of concrete results from the so-called “third arrow” of Abenomics, which was supposed to encompass policy initiatives to raise Japan’s lackluster growth prospects. An example of desired change would be labour market reforms to increase employment flexibility and encourage hiring.
The dropping yen has brightened prospects for export-oriented firms and helped to raise inflation, one of the objectives of Abenomics to dispel fears of a prolonged deflationary period in Japan. Among the favoured industries currently in Japan in our view are industrials, health care, information technology, transportation, and software and services. While portfolio weightings in Japan are below benchmark levels, the diversity of valuation in the Japanese stock market allows ample scope for active stock selection.
Among stock selection attributes that are currently being emphasised are strong valuation characteristics, earnings growth, financial quality, exchange rate sensitivity and smaller capitalisation size. We believe the small-stock segment of the Japanese market is relatively more attractive than larger companies.
Cash holdings by businesses and households in Japan have recently made record highs. Household financial assets held in cash are about 870 trillion yen alone (over $8 trillion). This very large pool of cash could potentially be used in part to purchase risk assets in domestic and kokusai (world outside Japan) markets if prevailing cautiousness shifts to greater optimism.
Asset allocation shifts by Japanese investors are of key importance. The Government Pension Investment Fund (GPIF) is the world’s largest institutional investor, with assets of over $1 trillion. The GPIF had previously held about two-thirds of its assets in Japanese government bonds, or JGBs. It has been diversifying its portfolio, with an objective of reducing exposure to JGBs while adding more domestic stocks, foreign stocks and foreign bonds. These moves together with asset allocation shifts by other institutions and greater risk-taking by households could impact positively on asset prices.
While the Japanese economy faces significant headwinds, particularly from demographics (a projected population decline) and a rising dependency ratio as the proportion of elderly increases, policy initiatives to increase female labour force participation and productivity could help lift longer-term growth potential.
Ronald D. Frashure is chairman and portfolio manager at Acadian Asset Management