Standard Life Investments

Published Article

Investment Week – Bull Bear - Japan


Bull points

  • Strong, stable government with commitment to far-reaching reform
  • Consumer and corporate confidence are on the rise

Bear points

  • Concerns about the outlook for selected ASEAN countries, which are among the key markets for a wide range of Japanese companies
  • Many Japanese companies’ profitability metrics remain challenging

For the first time in years, Japan enjoys a strong and stable government which is taking decisive action to tackle Japan’s structural problems. Prime Minister Shinzo Abe’s commitment to reform, along with the Bank of Japan (BoJ)’s shift to a more pro-growth stance, is resulting in a supportive backdrop for a range of Japanese businesses. Better economic data is feeding through into stronger consumer and corporate confidence. And the yen’s correction is restoring the competitiveness of Japan’s companies overseas.

Prime Minister Abe’s preparedness to take tough decisions when required is evidenced by his decision to press ahead with an increase in the domestic consumption tax rate – a move that is necessary if Japan is to tackle its massive debt burden. Consumption trends in Japan have been improving in recent months and there has been considerable concern about whether the tax hike could force these down again. In our view, these concerns are over-done and we expect the upturn in domestic spending to prove relatively robust.

As Japan’s consumers have begun to spend more, they have increasingly been doing so online. This is driving demand for superior distribution facilities, as well as for a better transport infrastructure. Japan’s largest property developer, Daiwa House Industry, seems well placed to benefit from demand for additional warehousing/distribution facilities. Infrastructure spending presents additional growth opportunities. Ongoing work on the orbital highway surrounding Tokyo is one high-profile example of the kind of projects under way to upgrade Japan’s transport infrastructure.

In line with recovering consumer confidence, there are signs of improving sentiment among Japanese corporates. This is being driven by several factors, including stronger earnings, the rising equity market and the global economic recovery. This more confident mood should prove positive for a range of businesses tied into the corporate investment cycle. IT multi-services vendor Otsuka primarily focuses on small and medium-sized enterprises (SMEs). In our view, a more positive IT investment cycle would likely boost Otsuka’s growth potential.

Higher spending on IT is just one example of how corporates’ increasing optimism is driving up capex levels. Japan’s auto industry, for example, is increasing capex as it seeks to ramp up production to meet stronger demand. This should have positive ramifications for a wide range of companies tied into auto production. One example is Keyence, whose sensors and measuring instruments are deployed in automated industrial and manufacturing environments, including the auto industry.

Countering these positives on the domestic front, Japan’s companies may face stiffer challenges in terms of their export markets. The ASEAN countries represent key markets for many Japanese companies and their growth prospects are now being buffeted by a range of headwinds.

In addition, many Japanese companies continue to struggle to generate sufficient returns to cover their equity cost of capital. This confirms the merits of a focus on companies able to generate improving returns and with sustainable business models. Hence, active stock selection is critical when investing in Japanese equities.

Shigeru Oshita, Chief Portfolio Manager Sumi Trust for Japanese Equity Growth Fund, Standard Life Investments