Japanese market survives volatility.

Japan’s equity market weathered an onslaught of selling in February by global macro hedge funds who were disappointed that the Bank of Japan (BOJ) didn’t accelerate its easing plan, according to a new research report from Nikko Asset Management (Nikko AM), a related entity of Tyndall Investment Management Limited (Tyndall AM). As Japanese equities weakened and the yen appreciated, global risk markets dipped, though most rebounded quite quickly following the February trough. Risk markets will likely continue to be volatile through to the end of the second quarter, however, as underlying fundamentals remain intact, Nikko AM’s view is to maintain its longstanding overweight on global equities, and Japanese equities in particular.

“In our view, Japan does not need a much weaker yen, nor does the BOJ have to add to its monetary easing plan to achieve decent economic growth or a positive equity market,” said John F. Vail, Chief Global Strategist at Nikko AM’s Tokyo head office. “In fact, as the yen stabilises and forex hedge losses dissipate, this should accelerate corporate profitability and push up Japanese stock prices. This would be a boon for U.S. dollar-denominated investors, who would benefit from the rising stock market without losing half the gains from yen weakness. Japan’s Price-Earnings Ratio is very attractive, especially given the positive surprises in the current earnings season.”

Japan’s 2013 fourth quarter GDP growth was 1.0%, far below the consensus of 2.8%. However, Nikko AM’s research suggests that Japan’s GDP is greatly understated due to continuously falling inventories, and we expect that the figure will be revised upward. Assuming inventories had not declined, GDP growth in the fourth quarter would have been 3.4%. Despite such numbers, Japan had the highest year-on-year growth rate out of the G3 in both the third and fourth quarters of 2013, culminating in a 1.6% year-on-year growth for calendar year 2013.

Personal consumption in Japan also grew strongly in the fourth quarter of 2013 and should continue in the first quarter 2014, as buyers front-run the 3% VAT hike due in April 2014. We expect personal consumption in the second quarter to plunge following the VAT hike by as much as 13% quarter-on-quarter (seasonally adjusted annual rate) and minus 1% year-on-year, but will likely be reversed in the third and fourth quarters of 2014. This would lead to year-on-year growth in personal consumption being flat by the end of 2014.

Thus, we continue to believe that Japan’s recovery is intact, and our forecast is for 5.3% GDP growth quarter-on-quarter (seasonally adjusted annual rate) in the first quarter of 2014 and 2.0% GDP growth for calendar year 2014.

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The Japanese market has some things to teach investors.

At a time when investors from developed nations are facing the relatively new challenge of the ‘hunt for yield’, investors from one of the world’s largest economies are old hands at the game.

And, according to major international asset manager, Principal Global Investors, there’s a lot to be learned from the strategies they have adopted to address issues relating to low or no GDP growth, massive debt and a zero interest rate environment.

The economy in question is Japan.

“The fact is that Japan was a forerunner to many of the issues that have now become endemic in advanced economies and are causing investors and investment managers to rethink their entire strategies,” explained Grant Forster, Australian CEO of Principal Global Investors. “Japanese institutional investors have attracted ongoing international attention as investors worldwide maintain a watching brief on where those funds, previously invested domestically, might land outside of Japan.”

As Mr Forster pointed out, while one-time poster child economy Japan may now be best known for its decade-plus doldrums, it is still the world’s third largest economy – and not just any economy at that.

“The Japanese market is highly sophisticated and despite its well-publicised macro difficulties, life there – including steady and intensive investment – continues,” he said. “What Principal has observed through a growing presence there is a range of investment patterns that, given the global conditions we are now facing, may well be instructive to investors elsewhere.”

Hitoshi Itagaki, President of Principal Global Investors (Japan) Ltd. makes a number of observations along these lines.

“Principal Global Fixed Income has seen, first hand, the effects of the Bank of Japan’s (BoJ’s) policy moves to weaken the yen,” he explained. “The BoJ’s massive buying of Japanese Government Bonds (JGBs) has effectively pushed Japan’s institutional investors out of the country in search of foreign assets and higher yields. Bonds denominated in U.S. dollars have received particular attention, and with low yields on Treasuries, and some areas of fixed income not typically known for drawing the interest of Japanese investors have been garnering attention: investment grade credit and high yield.”

Mr Itagaki went on to say that, during September, the Ministry of Finance International Transactions data has been showing data to support the anecdotal evidence he has been seeing in the marketplace. This recent data points to net purchases of foreign bonds, a trend the Principal fixed income team expects to continue.

He then turned to the issue of Japanese trends in equity investing, which are also changing.

“Our team has noted that Japanese retail investors are looking to equity income strategies to provide their portfolios with much-needed yield. With very low domestic yields and the recent weakening of the yen, they seem to have a renewed thirst for diversification beyond their home market,” he said.

Mr Itagaki also gave some perspective on the current Japanese view of Australian equities – with which Japanese investors have long been comfortable given historical relatively high dividend yields.

“Amid the slowdown in Australia’s major trading partner, China, Japanese investors have recently shown more interest in both US and Canadian equity income strategies – particularly Canada,” he said. “With its commodity-rich economy and above-average dividend yields, Canada offers many parallels to Australia, which Japanese investors find appealing. This is bolstered by the fact that North American growth prospects have improved rather than slowed.

Mr Itagaki also believes the multiboutique approach of the Principal allows institutional investors looking for yield to more readily create income oriented solutions under the one roof. For example, investors seeking yield could blend specialist managers allocating to preferred securities, investment grade short and long duration, and emerging debt all using specialist boutiques within Principal Global Investors.

According to Mr Forster, what it all comes down to – whether in Australia, the United States or Japan – is that investors are seeking managers that can be flexible in the range and number of solutions they offer.

That means managers that can both anticipate change and be responsive to the challenging situation in which investors find themselves. The managers who are providing investors with broad ranging expertise and open thinking are the ones that are delivering the value. They are the ones that investors should be seeking.”

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