The excellent and eloquent Simon Somerville, Jupiter Japan’s manager, recently described Japan as the “Marmite market”.
He’s right; there appears little appetite for anyone to evaluate and come up with the conclusion that Japan is simply ‘doing OK’.
I’ve recently discussed how Japan’s economy was in fact ‘doing OK’ and there were reasons for future hope.
We expect the Japanese economy to continue to heal at a moderate pace, aided by government reform and the hyperactivity of the Bank of Japan.
Performance of indices since Shinzo Abe assumed office
Source: FE Analytics
The economic backdrop is important, but in my view that's not the real story here – the opportunities at a company level are immense.
Yes, it is helpful to have an economic tailwind and the assistance of the Bank of Japan can allow other investors, particularly US hedge funds, to get excited and see Abenomics as the catalyst they require to invest in Japan.
But even without the help that an improving economy can exert upon investor confidence, there are riches to be found in Japan’s stock market.
At a headline level, Japanese stocks are good value, from all of a historical, relative and absolute perspective.
Assuming 10 per cent earnings growth from the TOPIX companies in the next two years, which I think is achievable, then you can make a case that Japanese stocks are trading on 11xs price/earnings multiple 18 months forward (the Japanese year end is in March).
More importantly for active managers, there are some wildly cheap stocks trading at ludicrous valuations and certain shares on undeservedly expensive premiums.
On the cheap side, the banks, real estate and consumer names are all very attractive; while on the flip side we would totally avoid the low growth, high valuation consumer staple and pharmaceutical sectors.
One of our selected managers highlighted Mizuho Financial as a great opportunity; Mizuho currently trades on 6x earnings, a price to book of 0.7x (which we think is an over-estimation as they are yet to book unrealised gains on investments of 40 per cent) and it is generating a return on equity of 12 per cent. Nuts.
Japan is presently a stock-picker's dream, in part because nobody cares about it (most Japanese stocks are under-researched) and in part because investors have mostly given up trying to make money there. In short, there's treasure to be found on this magical island, but it will take patience and hard work to find it.
However, as we all know, earnings are cyclical and good profits growth can easily dissipate as quick as it has come, so what gives us the confidence that Japan is now a ‘buy and hold’ market, rather than merely a trading opportunity?
While it is a slow burn, (this is Japan after all), there are clear signs of improvements in corporate governance. 63 per cent of companies now have at least one independent director on their boards and more are following suit in anticipation of the introduction of the corporate governance code in 2015.
In addition, most Japanese corporate managements seem to be praying to the god of shareholder returns and there has been a 57 per cent rise in share buybacks announced over the last year and dividends are up 20 per cent over the same period.
Of course, not all companies are changing, Sony has notably just failed to pay a dividend for the first time since listing in 1958, and there remain a large cohort of dinosaurs drifting slowly towards extinction, but you can avoid those misfits and invest in companies embracing a better tomorrow.
While the corporate governance code is important, the stewardship code is equally vital to making Japan investable once again.
A number of asset managers and influential investors have signed up to this initiative, with the intention to pressurise corporate managements to behave better on behalf of their shareholders. If taken seriously, which it will be in some quarters, this can only be good for Japanese investors.
The final market driver that we believe can be very potent in the coming years is the change in asset allocation at pension funds, led by the behemoth public sector Government Pension Investment Fund (GPIF).
The GPIF is set to raise their equity allocation through the next few years and this increase to Japanese stocks should be a major support to markets. They are right to do so; with equity valuations low, dividends attractive and government bonds insanely expensive, this has got to be sensible.
The other thing in their favour is that they have an indiscriminate buyer of any domestic government bond they want to sell in the form of the Bank of Japan.
In short, if all the above plays out there is an extremely bullish case to be made for Japanese equities.
As always, we operate and invest with a high level of scepticism and recognise that change will be slow in Japan, so our view is that you buy Japanese stocks on weakness, remain overweight and would hope to see returns of 50 per cent in the next three years.
Tom Becket is chief investment officer at Psigma. The views expressed here are his own.
