Call it the dilemma of the Japanese equity investor.
By all traditional methods of analysis, the country’s shares should be thriving. Valuations are low, profits are strong, and shareholder returns are higher than ever. And, that's even before you add unprecedented stimulus by the Bank of Japan, and an economy cruising to its longest run of growth in decades. For investors who did the research, being a bull seemed the logical choice.
And once again, they were wrong. The benchmark Topix index is slumping: Japan is the worst-performing developed Asian equity market this year. That's largely because of the country's currency, which strengthens at any piece of bad news in the world, and then damages the earnings prospects for the country’s giant exporters. The gauge fell as much as 0.8 per cent to 1,737.93 Wednesday.
This is the market where investors who want to focus on fundamentals must come to terms with stocks sometimes moving to a different beat. The yen gained in two distinct phases this year, both with little to do with Japan: one was due to dollar weakness in January, while the other was because of the global equity rout the following month. “It is true that Japanese equities are swayed in a significant way by external factors,” says Hiroshi Matsumoto, who heads Japan investment at Pictet Asset Management in Tokyo.
Matsumoto’s solution is to measure what can be measured, and accept — or even ignore — the things he can not foresee. He cites developments with North Korea as one example, after a leadership summit between the US and the reclusive Asian country was unexpectedly announced last week.
“It is always difficult to predict such unknown factors,” he says. What can be reasonably predicted “is the economy and earnings forecasts.”
One positive, Matsumoto says, is that if companies are sold off excessively because of the yen's influence, that gives him an opportunity to pick bargains. Nader Naeimi of AMP Capital Investors takes a different philosophical approach. If Matsumoto has made his peace with the situation, Naeimi refuses to do so. His view — sometimes espoused by others in recent years and always proved to be wishful thinking — is that the yen's damaging influence on Japanese stocks is poised to end. For him, yen strength should no longer be a concern. He predicts that nascent inflation will support domestic businesses and weaken the yen's grip on the stock market.
ChartMatter of time
For Tony Glover, the Tokyo-based head of investment management at BNP Paribas Asset Management, it is just a matter of time. Over a long enough time period, Japanese stocks will eventually move in tune with profits, he says.
“We still believe that the stock market reflects earnings, company fundamentals, in the long run,” he says.
Others, such as Jonathan Allum of SMBC Nikko Capital Markets, have drawn attention to the dilemma, lamented it and expressed hope that Japan can one day become a market that is more attuned to fundamentals.
“There was a time in the 1980s and most of the 1990s when the Japanese market was more driven by internal factors,” Allum said in an email. But since 1998, shares in Tokyo have been guided by external influences and from 2005, the correlation between stocks and the yen has been “very tight and very frustrating.”
How long a return to fundamentals will take is open to speculation. In the meantime, while the bulls have different philosophical perspectives on the conundrum, their ultimate view on it, as expressed by their investment decision, is the same.
“Japan is probably the most oversold market with strong earnings growth,” Naeimi says. “It is a great time to be bullish again on Japanese stocks.” Matsumoto echoes that sentiment.
“Of course, we could make mistakes,” he says. But “we believe Japan offers good value.”