Identifying winners and losers in Japan

Kwok Chern-Yeh, Deputy Head of Equities, Asia Pacific and Head of Investment Management, Japan

Investors should target companies with independent growth drivers to avoid the pitfalls and capture the upside in 2020 and beyond.

Despite a resurgence in the second half of 2019, Japan’s equity market has comfortably underperformed global peers over the past two years.

Although there are tentative signs of stabilisation in global growth, and the US and China have reached a trade agreement in principle, remaining tariffs and economic and political obstacles to a more comprehensive deal dent our confidence about a potential rebound.

Persistent trade tensions not only between China and the US but also Japan and South Korea have implications for global supply chains and corporate spending.

Domestically, the negative impact of October’s VAT hike has been a major focus, crimping spending among households.

With the Bank of Japan on the sidelines for now – having kept rates on hold in October even amid growth concerns – the government has announced a ¥13.2 trillion ($121 billion) spending package.

However, only a third of these funds have been allocated to the supplementary budget, with the rest to be distributed over several years – reducing the bang for buck. Bear in mind, the government has to balance economic revitalisation with managing the nation’s debt sustainability.

For investors, the fate of the industrial cycle remains a critical consideration.

For investors, the fate of the industrial cycle remains a critical consideration. Although inventories look leaner, downbeat sentiment in the manufacturing sector points to an L-shaped recovery, rather than V-shaped.

In the event that momentum in the industrial cycle rebounds, Japanese equities remain a good tactical play. The practice of returning cash to shareholders is catching on fast.

However, if the US tips towards an end-of-cycle event amid trade disputes, the Bank of Japan may struggle to contain yen appreciation. That would adversely impact equity market performance.

Given such uncertainties, investors should focus on companies with independent growth prospects. We see two areas to target: self-reliant firms that don’t depend on external stimulus; and diversified companies that benefit from non-discretionary offshore earnings.

Among domestic firms, those that have made themselves leaner, more efficient and more productive are best placed to grow irrespective of macroeconomic conditions. Skincare products manufacturer Shiseido* is running a cost-cutting programme even as it expands.

At the same time, investors should look to firms that have diversified overseas to alleviate dependence on their domestic market. A company such as Pigeon* – a maker of baby products – is benefitting from rising middle classes in fast-growing China and Southeast Asia.

Firms with strong balance sheets and leading market shares are best able to drive their own growth and sustain dividend payments. They can also capitalise on record low interest rates to push through growth-enhancing mergers and acquisitions.

For instance, non-life insurer Tokio Marine* is buying a US-based insurer to tap into the market for wealthy clients; air con specialist Daikin* has bought a European freezer manufacturer; and Nippon Paint Holdings* acquired the leading decorative paint business in Australia.

After several false dawns, we are seeing strong momentum behind corporate governance improvements. They can make Japan a materially better market for investment and go some way towards unlocking the tremendous value on overcapitalised balance sheets.

Understanding environmental, social and governance (ESG) factors enables investors to assess the sustainability of a company’s business model and its ability to prosper. Such detailed due diligence will be key to identifying Japan’s winners and losers in 2020 and beyond.

*We hold the stocks in bold in our Aberdeen Standard Sicav I Japanese Equities Fund.


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