What did you learn from your recent trip to Japan?
“We went at the start of June for a week and saw a lot of different companies across a lot of different sectors. I guess the overriding message is that things are pretty positive at the moment.”
“From the manufacturers, the order environment’s very good, both domestically and overseas. The consumer facing businesses seem to be having decent sales environments and actually it’s kind of reflected if you go to the restaurants and the shops, there’s kind of a buzz out there at the moment. I think everything’s going quite well.”
“One of the main reasons that we went at the start of June is because we had the sales tax hike in April. To put that in perspective, the last time the sales tax was increased was back in 1997 and within a year the Japanese economy had fallen into recession. So there’s been a big concern about whether something’s going to happen like that again.”
“I guess from speaking to the companies it seems that we did see a lot of up front buying before the tax hike and then we saw a reactionary decline as you’d expect but actually since then, probably the improvement in the sales environment has been better than they’d originally thought, so that makes us quite positive as well because I think a lot of the companies kind of expected, or they priced in the worst case scenarios in terms of their earnings.”
“Because things seem to be getting back on track maybe quicker than they thought I think possibly we could see some earnings upgrades as we progress throughout the year. So that should be good for the market.”
What is the outlook for Japanese equities?
“We’re positive on Japan at the moment and I guess there are a few reasons for that. The main reason is the outlook for inflation. So Japan’s been in deflation for over two decades and it’s very bad for the private sector, very bad for the economy and bad for markets. I guess going into a bit more detail on that, so if you’ve got zero interest rates but you’ve got deflation, then real interest rates are positive. And so looking at the consumer, if prices are going down next year people hold off because why buy something now when they can buy it for cheaper in a year’s time.”
“In terms of the corporates, if you have positive real interest rates then you don’t need to spend money on investment and R&D because that’s risky investment and it might not see a payoff. You can just hold your money as cash and you make real returns. So this is kind of the deflationary mentality and it really kind of supresses economic behaviour and so the hope for Japan is that we’re actually seeing a shift toward inflation now.”
“If we get inflation and real interest rates turn negative so now the private sector, they can’t just sit on cash anymore because there’s an opportunity lost holding cash because the real value of that cash is now getting eroded. So it encourages consumers to go out and spend. It encourages companies to start doing productive investment. And hopefully that helps GDP growth in the short term and the long term. If that happens then it should be very good for the economy and it should be really good for the market as well.”
“The Japanese market is trading at very low valuations, especially relative to history, but also now lower valuations than the US and European markets. The last time Japan traded at a discount to Europe was in the 1980s. Clearly it looks very cheap here and we feel that there is a good possibility that we could see more sustainable inflation going forward and so that makes us positive on the market.”
What companies will benefit from rising inflation?
“I think first and foremost it would be the banks. If we do have negative real interest rates and it does encourage this spending environment then effectively it should encourage releveraging of the Japanese economy.”
“So more borrowing which would be something the banks haven’t seen for a long, long time. Hopefully at that point interest rates on loans the banks make will start to pick up, the yield curve will steepen and that will be very good for bank sector earnings.”
“The banks are trading at around 0.7 to 0.8 times book value which is right along the lower end of the historic range. It’s a discount to a lot of the global peers. It doesn’t price in any releveraging scenario for Japan. We think that if we do see that scenario unfold that will be very positive for the bank share prices.”
What is your fund management process?
“We use a combination of a top-down and bottom-up process. From a top-down point of view, clearly all companies operate within the global economy and so understanding how different sector and companies are geared into the global economy helps you to understand the earnings prospects in the future.”
“And so we like to use that as a starting point for really setting up the structure and the strategy of the portfolio. Then after that we like to dive into companies with much more of a bottom up process. This is really understanding the fundamentals of the companies, the demand/supply environment, the competitive environment, correlations with how they’ve performed in the past with different top-down macro environments. So it ties in the bottom-up to the top-down. Understanding if there’ve been structural changes which could cause a divergence in those trends. And then we look at valuations.”
“So if we can find a company which, from a top-down perspective, we like the macro trends and also from a bottom up perspective it’s got very good fundamentals and then we can find that it’s also cheap maybe relative to its history and relative to its peer group, then that’s kind of the ideal investment that we’d like to make. So it’s really combining the top-down, bottom-up, focusing on valuations and finding companies with good upside.”
