The BlackRock Investment Institute (BII) has recently increased its overweight position to Japanese equities.
The TOPIX has been a relative outperformer in global equities and the BII see the relatively benign economic environment, as well as strong cashflow dynamics and accommodating policy as positive drivers.
Japan’s benchmark TOPIX index is the only developed market benchmark up year-to-date compared to the 3-7% declines for U.S. and European benchmark indices.
Ben Powell, APAC chief investment strategist within the BII said the institute has increased its overweight to Japanese equities amid a broader preference for equities following the knock risk-assets have suffered.
This, he said, was due to supply-driven inflation earlier in the year, compounded by the energy shock from the ongoing conflict in Ukraine.
“For Japan, we see the relatively benign domestic growth backdrop, rising dividends and buybacks and supportive monetary and fiscal policies as reasons to add to our overweight and remain invested through a period of heightened uncertainty,” said Powell.
Benign growth backdrop
While Japan has had a temporary setback to activity due to rising Covid cases, the shock from higher commodity prices is, according to Powell, of more significance.
“We believe the shock will weigh on growth and stoke higher inflation globally,” he said. “Yet we see this impact to be felt most starkly in the euro area, and less so in other developed regions such as the U.S or Japan.”
The strong Covid restart in Japan has helped provide a level of protection against the conflict in Ukraine.
Data for the quarter ending December 2021 showed Japanese GDP growing at an annualized rate of 4.6% with spending on services particularly strong and private consumption expenditures growing at an annualized rate of 10%, according to Bloomberg.
The government is also preparing additional spending measures to soften the impact of the higher commodity prices.
Corporate results for the quarter ending December 2021 also showed Japanese companies on a firm footing. Aggregate revenue for TOPIX companies grew 5.7% and operating profits rose 24.7% according to the Ministry of Finance.
According to Refinitiv, Japanese companies’ operating leverage – a measure of how revenue growth translates into growth in operating income – is running at a 25-year high.
“This suggests that even with low-to-mid single digit revenue growth expected in the coming quarter, companies can absorb higher costs and potentially generate profits that could surprise on the upside,” Powell added.
The Bank of Japan has demonstrated its commitment to defend its yield curve control target of 0.25% on 10-year Japanese government bonds.
This is both likely to keep Japanese interest rates low relative to its peers and boosts the appeal of Japanese equities over bonds and credit.
“The key risk for Japan’s equity market, in our view, remains a persistent global slowdown, given the export-oriented business of its large companies,” he said.
“That means the market remains vulnerable to global growth scares – such as the ongoing one following the Ukraine invasion.”
Opportunity in equities
Thomas Patchett, investment specialist on the Baillie Gifford Japanese equities team said that digitalization and automation are just two examples of secular growth trends proving accommodative to long-term performance.
“Japan’s slow rate of adoption in ecommerce, cashless payments, digital advertising, and software-as-a-service – relative to other developed markets – offers a long run-rate of growth to nimble and new operators within this space,” said Patchett.
He also said that reshoring – accelerated by geopolitical and environmental factors – combined with labor shortages and wage inflation could provide a boon to the world’s leading robotics and automation companies, most of which are Japanese.
“Companies like Nabtesco and Harmonic Drive look primed to sate China’s ravenous appetite for robotics, especially within the collaborative robotic space.”
Accommodative fiscal and monetary policy, a stable growth environment and improvements to corporate governance are all components of an improving investment case for the country.
