While Japanese companies’ market price per share has de-rated the profit outlook has improved significantly, according to Schroders’ Andrew Rose.
The manager of the £2.6bn Schroder Tokyo fund said price-to-book ratios of Japanese companies remain stuck but returns on equity are almost at parity with the rest of the world, making the country an attractive market compared with international peers.
“In the Abenomics era the market has more than doubled but profits have gone up more-so, the market has been de-rated,” Rose said. “This means that, on an international comparison, Japan is now relatively cheap.
“The market has never been cheaper versus the rest of the world in terms of price-to-earnings [P/E] ratio.”
Indeed, over the past 10 years, the Japan’s high CAPE ratio [cyclically adjusted P/E] has been a reflection of poor earnings, with returns on equity significantly lower than the rest of the world.
However, the profitability picture is looking more positive now, with earnings per share on the Tokyo Stock Price Index (TOPIX) at around all-time high levels.
TOPIX earnings per share (EPS)
Source: Schroders
According to Rose, who has also run Schroder Japan Growth investment trust since 2007, although profit growth will slow in the coming months it should remain positive.
“Earnings per share on TOPIX are at round about all-time high levels,” he explained. “Equally you would have to say momentum is slowing with more downward than upward revisions. Why is that?
“Possibly because companies are using a stronger Forex rate, also because costs are going up.”
Some of the reasons for the cost increase, Rose noted, is higher wages in a country with labour shortages – with Japan's job-to-applicant ratio hitting a 43-year high last year.
“There has been some spinoff from the tight labour market to the wage growth picture,” said the Schroders manager. “Wages are growing 1.5 per cent, the highest they have been for a long time.”
Rose added: “In Japan, well paid, full-time jobs used to grow less rapidly than part-time jobs. But they are now growing at the same rate, which is pushing up overall wages, so that’s good news.”
With wages growing and companies demanding higher prices for their products, the Schroder Tokyo manager said inflation in the country is also starting to rise, although he noted that it is still nowhere near the Bank of Japan (BoJ) target of 2 per cent.
He said: “The Bank of Japan has actually postponed hitting that target six times and in the most recent announcement they gave up any time reference whatsoever, so that tells you all you need to know about the ‘realistic-ness’ or otherwise of hitting that 2 per cent target.
“Does that matter? I think not; 2 per cent is really a number and, as long as you can actually get inflation expectations in the system that has a lot of positive spinoff effects.
“I think there are some signs in terms of the output gap, in terms of the labour market to suggest that might be happening,” Rose explained.
Latest data from the Japan Statistics Bureau showed core inflation rose by 0.5 per cent in 2017, although consumer inflation slowed down in April this year.
Historic CPI inflation in Japan
Source: Japan Statistics Bureau
Another tailwind for the Asian country is the policy backdrop, that Rose said remains supportive especially when looking at the yield curve control.
The measure was introduced by the BoJ in 2016 to revive the economy and consisted of keeping its 10-year government bond yield at zero per cent.
Rose explained: “Japanese monetary policy is a sea of acronyms. The one that really matters is ‘YCC’, yield curve control. This was put in place in September 2016 and it is unorthodox. It seeks to control the long end of the yield curve.”
“The long end of the yield curve has been nothing if not well controlled at around zero,” said the Schroders Tokyo manager. “So, when negative interest rates came into play in 2016, the Bank of Japan was concerned that markets over-reacted and that impacted pension funds and insurance companies and bank profitability.
“They wanted to stabilise rates at their desired level, they have been incredibly successful in doing that.”
When it comes to the negatives, Rose pointed out Japan’s headwinds mainly have a geopolitical nature, with the most obvious one being the trade war between the US and China, Japan’s two biggest single country export markets.
“The US and China are Japan’s two biggest single country export markets at 19 per cent each,” he said. “To put that in context exports only account for 16 per cent of Japan’s GDP, so that’s about 3 per cent each for China and America.
“Japan is an important part of Chinese supply chains, also indirectly in terms of the impact on the currency or the stock market.”
Performance of fund vs sector & benchmark under Rose
Source: FE Analytics
In the 14 years that Rose has overseen the Schroder Tokyo fund, it has delivered a 176.35 per cent total return compared with a 130.03 per cent for the average IA Japan sector fund and a 154.57 per cent gain for the TSE TOPIX index.
It has an ongoing charges figure (OCF) of 0.91 per cent.