In a year that has been marked by some volatility, one market has stayed consistently in the green – Japan. In local currency terms, the Morningstar Japan index is up 26.0% so far this year, while the Morningstar Hong Kong index is mostly down 16.8% year-to-date, the Morningstar Singapore index is up 0.5% and the Morningstar Canada index is up 2.7%.
But despite this, foreign investors may not have seen these same numbers, partly because of the depreciation in the Japanese yen. The currency’s weakness contributed to strong export performances and corporate earnings, but its depreciation has also resulted in foreign exchange losses for non-yen-based investors when translating their gains back into the strengthening greenback. Consequently, these losses have partially offset the equity gains.
Such a situation may have discouraged overseas investors from increasing their allocation to this new investor favorite. But this scenario could change in 2024.
When Will Interest Rates Return to ‘Normal’?
Thomas Poullaouec, head of multi-asset solutions, Asia Pacific at T Rowe Price, continues to prefer Japan over other countries like China. His portfolios maintain a “very modest underweight in equity,” even as the Japanese market represents an overweight position.
When Japan puts its borrowing rates back into positive territory, Poullaouec thinks the Japanese yen could appreciate. The trigger will emerge around spring, during the so-called ‘shunto’, or wage negotiations. “The next shunto negotiations will give us guidance about wage appreciation in Japan. If that remains close to or above 2%, that would be a good signal for the Bank of Japan to remove the negative interest rate policy,” he says.
He continues: “I am expecting that, in 2024, that can be slightly different because the BOJ might act in terms of removing negative interest rate policy and that will support the Japanese yen.” He sees more room for the yen to appreciate before hurting corporate earnings.
In Japan, Inflation Isn’t Always Bad
Lorraine Tan, director of Asia equities at Morningstar, is also monitoring rising inflation in Japan. She says: “One of the good things about the inflation coming back in Japan is that hopefully it will incite or invigorate some reinvestment and expansion activity in Japan itself.” For instance, improved corporate profitability from rising prices could provide the financial resources necessary for expansion. Meanwhile, higher wages could also stimulate consumer demand.
“If [the trend of reinvestment and expansion activity] happens, I think the outlook for growth is more sustainable,” she says. This links back to her current top picks in the country.
Instead of capitalising on the domestic consumption story, Tan focuses on the laggards this year, such as the export-oriented company stocks. Harmonic Drive Systems manufactures high-precision reduction gears while Nabtesco Corp makes motion control technology-based components. Osaka-headquartered Daifuku provides automation solutions for warehousing, storage, and transportation. Fanuc also produces industrial robots.
“Factory automation is sensitive to capital spending activities globally and that includes China. If the outlook of the industrial side improves, there are some really good names there that we like,” says Tan. “Those are high-quality companies and very moat-y companies that we think have lagged. That’s where we would focus our attention.”
Any Upside for Japan Banks?
A rally in banks and other financial names this year has lifted the Japanese broad market indexes. Tan thinks the outperformance has driven the sector closer to what they are worth. She says: “The Japanese banks have done very well. We had them as a top pick for a while, but they have come up a long way. Opportunities there in terms of the financials are probably a little bit more limited going forward,” says Tan.
Oliver Lee, a client portfolio manager at Eastspring Investments, told Morningstar that their Japanese value portfolio has recently taken profit from financial and auto names. “We’ve rotated that capital into domestic names, into defensives, and more recently into chemical names which have been a real laggard area of the market on weakness around demand and pricing. And so, we still find plenty of opportunities.”
