After more than three decades, Japanese equities have hit record highs, but does the asset class have more room to run?
Zurich head of macroeconomics Guy Miller says: “I have been in markets since 1991 and I was on the US equity desk, and back then everyone was bullish on Japan. Any money people made in US equities back then was deployed into Japanese equities. It has taken 34 years to get back to the record level.”
“Two things have really happened there — one is the weakness of the yen, that has been a big factor. The second is around corporate governance — the unwinding of cross shareholdings and better use of shareholder capital. None of those things are particularly new, but it’s a case of a lot of things coming together.”
Yen weakness has the effect of boosting the earnings potential of Japanese exporters, and enhancing the returns available to those whose primary currency is not the yen.
Morningstar Investment Management chief investment officer Mike Coop has been taking some profits on Japanese equities, but remains keen on the asset class.
Third arrow of ‘Abenomics’
He told FT Adviser: “Japan’s reforms have been happening for the past seven or eight years, and we have been overweight to there for a good while. The reforms that are making a difference now were the third arrow of the ‘Abenomics’ policies announced in 2012, but it has taken this long for the market to realise the change that is happening.”
Abenomics was a series of three broad policies implemented by former Japanese Prime Minister Shinzo Abe.
Branded as the “three arrows”, one arrow focused on looser fiscal policy, one on looser monetary policy, and the third on corporate sector reform.
It is the changes associated with the third arrow that Coop and others say are having a profound impact on Japanese equities. He believes the changes are profound because they will improve companies’ earnings potential.
Comment on the quality of the Japanese market, Coop says the fact it has taken 34 years to beat the precious high is as much a function of “how crazy valuations got in the 1980s”.
One of the arguments cited by those more sceptical of the durability of the Japanese equity rally is that it is a function of inflation rising in the country.
Advocates of that view say that while Japan’s ageing population ensured very low inflation, investors in the country were content to own US or other developed market government bonds because the yields, while low, were still positive in real terms, and so there may be no need to buy equities.
But in more recent times, Japanese inflation has risen above zero per cent, and Miller says that such a change could prompt the Bank of Japan to move beyond its long-standing zero interest rate policy.
