Japan has been a big hit with investors in 2017, but we’ve been here before. Can the stock market continue to deliver for investors in 2018?
- Japan has been one of the success stories of 2018, but the strength has not been equally shared
- Funds that have focused on growth areas – robotics, technology – have notably outpaced those focused on ‘value’ areas such as banking or autos
- The stars are still aligned for Japan in 2018, but investors need to be selective
- Japan has been a big hit with investors in 2017, but we’ve been here before. Can the stock market continue to deliver for investors in 2018?
Japan was 2017’s big winner. A happy confluence of economic growth, structural reform and corporate strength saw it outpace its developed market peers, particularly in the second half of the year. But investors have been fooled before. Can the Japanese market continue its outperformance? Or is yet another short-term cyclical recovery, likely to wither as quickly as it has started?
The average fund in the IMA Japan sector is up 17.9% over the past year. The Nikkei is currently outpacing the S&P, fuelled by strong corporate earnings. This is good news for Japan investors, who have been patient. However, for funds within the sector, the spoils have not been equally shared. It has seen a wider disparity of returns than almost any other sector, with 30% between the top and bottom performing funds. The winning strategy has been to focus on growth – technology, robotics, service companies dealing with the ageing population or internet disrupters. Those who have sought out the cheaper areas of car manufacturing or banking have been left behind.
Japan’s new-found strength has a number of drivers: the economic backdrop has materially improved – after a slow start, the reforms of Shinzo Abe finally appear to be working to generate inflation and GDP growth. New corporate governance rules have seen companies use their cash-rich balance sheets more effectively as well as shareholder-friendly activity such as appointing independent directors and paying dividends. Japan has also been a beneficiary of growth in the wider region – Chinese factory mechanisation, for example.
There are no signs that this will ebb. More importantly, investors are getting this growth notably cheaper than they are getting it elsewhere. The valuation of the Japanese market is reasonable at a time when most other markets are expensive. Earnings growth remains a lot stronger in Japan than elsewhere.
However, it is still a market where selectivity is likely to prove fruitful. Yes, the banks and autos might see a small re-rating, but they are not where the exciting growth is to be found. Corporate Japan may have improved, but it is still given towards cronyism and poor allocation of capital. This is worst in the largest companies. While index-investing may have served investors well over the past few years, it may be a time to look beyond.
