Japanese stocks have lagged their global peers so far this year, as uncertainty over US-China trade frictions and the impact on the global economy have clouded the outlook for corporate earnings.
While the analyst revision index has already reached its typical bottom and earnings trends should stabilise in the coming quarters, share prices are likely to remain volatile amid a steady stream of political newsflow.
While not immune to external headwinds, the Japanese economy remains relatively stable. Confidence among Japanese manufacturers has clearly weakened, but sentiment in the non-manufacturing sector is holding up.
Employment conditions remain tight, with the job-offers-to-applicants ratio at record levels.
Capital expenditure plans are supported by non-cyclical factors such as investment in labour-saving technology and research and development.
Meanwhile, the Bank of Japan remains highly accommodative.
From a valuation perspective, Japanese stocks priced in a significant level of risk in late 2018, and continue to look undervalued at about 12x forward earnings.
With valuations testing historical lows in some parts of the market, there are opportunities to capitalise on disconnects between near-term sentiment and mid-term fundamentals.
As we move through the early stages of 2019's fiscal year, I am inclined to see how stocks behave in relation to earnings announcements and selectively add names at trough valuations, and where fundamentals are trending at cyclical lows.
While there have been no significant changes to the overall composition of our investment trust's holdings, I have selectively increased positions in oversold semiconductor-related companies and component makers.
New ideas are also coming from stocks with the potential to rerate as internal change leads to renewed growth.
I also continue to search for opportunities to invest in innovative companies at the pre-IPO stage.
Conversely, I have reduced the exposure to machinery and chemicals stocks where the risk/reward balance had deteriorated and near-term upside appeared limited.
I have also actively taken profits in strong performers in the retail and medtech sectors.
Nicholas Price is manager of the Fidelity Japan Trust
• Japanese stocks look undervalued at about 12x forward earnings
• The Bank of Japan remains highly accommodative
• Uncertainty over US-China trade frictions
• Confidence among Japanese manufacturers has weakened