After nearly two decades of crippling deflation, the new government’s plan to raise inflation via monetary stimulus has been viewed as a positive move by a number of industry experts.
Japanese equity markets have reacted very well to the stimulus packages; according to FE Analytics, the Topix has returned 22.77 per cent since January, making it the best-performing developed equity index in 2013.
Performance of indices in 2013
Source: FE Analytics
However Stewart (pictured), who manages the £7.5bn Newton Real Return fund, does not believe the rally is sustainable, and says that the sheer amount of money being pumped into the system means the situation is "likely to end badly".
"The recent quarter has continued to see strong local-currency performance in Japan," he said. "The new government, led by Mr Abe, promises a new era of monetary activism to finally shock the moribund economy out of its relative torpor."
"It is hard to say whether investors believe that more cheap money can really transform an ageing economy with a shrinking population; Japan has had the lowest interest rates in the developed world for more than 20 years."
"However, it will probably suffice for now that greater activism can light a fire under the equity market."
"As one of our investment team members noted recently – 'Japan seems to be a microcosm of what is happening in developed markets generally. Everyone knows it’s likely to end badly, but in the meantime the market is going up.'"
Stewart recently told FE Trustnet that the scale of central bank intervention has made the current investment environment the most dangerous he has witnessed in his 20-year career.
He says investors should not get carried away by rising markets in Japan, because nothing that its government has done has addressed the country’s poor fundamentals. Until this happens, he advises investors to steer clear of the region.
"We have often suggested that Japan represents an extreme and early example of the malaise affecting the bulk of the developed world."
"The demographic profile in Japan is likely to have shaped the country’s slow growth and tendency toward mild deflation," he said.
"Without significant reform and remodelling, administering steroids to a tortoise is unlikely to make it look like a hare for long."
"Moreover, encouraging inflation – the official target is 2 per cent – and currency debasement in an economy which has non-existent income growth, needs to import a significant proportion of its food and energy, and has a gargantuan public debt being serviced at yields (of less than 0.6 per cent on 10-year bonds) priced for deflation, seems like a high-risk policy," he added.
Stewart has managed Newton Real Return since its launch in March 2004. Over that time, the fund has returned 65.95 per cent while its benchmark – the Libor GDP 3m index – has returned 32.79 per cent.
Performance of fund vs index since Mar 2004
Source: FE Analytics
Newton Real Return has made positive returns in every calendar since its launch, except in 2011 when it lost 3.93 per cent.
Our data shows the manager currently holds 3.8 per cent of his portfolio in Japan. However, due to his concerns over the country’s economy, he says he is unlikely to add to his exposure anytime soon.
He commented: "The ruling party has made it clear to the corporate sector that its efforts at stimulus need to go hand in hand with improved returns to labour via rising wages."
"Such an initiative, which may also be a leading indicator for other 'rich' economies, clearly has implications for corporate margins and profits."
"Against this backdrop, we are not making a large strategic call on Japan, but continue to assess Japanese securities on their individual merits and in the context of our global themes."
"Japan has some fine companies, but it is fair to say that they often look finer from a distance. Our experience over many years, confirmed by recent analyst visits, is that closer inspection leads to disappointment."
"It may be that decades of near-zero interest rates sap the dynamism from the economy, and that this rubs off on management. Certainly the depressive effect of a falling domestic population cannot be overstated."
Although Stewart is by no means optimistic on Japan’s future, he says he is finding opportunities in the country due to the long-term themes within his portfolio.
"There are, thankfully, notable exceptions at still-attractive valuations. We like, and hold in portfolios, certain high-quality exporters," he said.
"Our healthy demand theme draws us to Japan’s generic drug industry, and net effects brings focus to the exciting recent telecommunications combination of Softbank and US operator Sprint."
"Moreover, certain consumer staple businesses have well-established brands and strong market positions with developing-world consumers."
Newton Real Return has an ongoing charges figure (OCF) of 1.61 per cent and requires a minimum investment of £1,000.