The 'icing on the cake' in Japan
Japanese equities have been routinely shunned by global allocators for decades.
They are often viewed as peripheral for Westerners, and have far less weight than the US or Europe in global indices.
But Japan has also become a victim of behavioural finance and investors' home market bias. After all, it is very remote from developed market global capital hubs and investors typically have more appetite for high-beta emerging markets.
However, Japanese equities are a powerful diversifier, with a respective correlation of just 0.66 and 0.70 to the US and Europe. A large part of this lower correlation comes from the currency component.
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Japan also has diminished exposure to the market squalls that often beset emerging Asia. On aggregate, Japanese companies have little exposure to China.
Having said that, the Chinese economic slowdown has weighed on some cyclical sectors such as robotics, factory automation and commodities, such as steel.
Japanese equities are also inexpensive and valuations already integrate a slowdown in global economic growth and downward revisions to consensus earnings estimates.
The P/B multiple is at a six-year low, at about 1.1x - down by about 15% since last summer. At such a low P/B, investors could expect annual gains in line with the return on equity at more than 7%.
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Separately, the market dividend yield is about 2.5%, to which we can add another 1% in share buybacks for a total return to shareholders above 3.5%.
Contrary to the US Federal Reserve or the European Central Bank, we have good visibility of the future actions of the Bank of Japan, which is in 'standstill' mode.
In 2019, the advantage compared to other major equity markets will be Japan's stability. We prefer domestic companies and multinationals exposed to the US market.
Public works and infrastructure-related companies offer attractive valuations and good visibility without being exposed to the global cycle.
We like companies with strong balance sheets, those paying good dividends while having a low payout to ensure a sustainable payment, with the buyback optionality as icing on the cake.
Joël Le Saux is portfolio manager of the OYSTER Japan Opportunities fund at SYZ Asset Management
Bull Points
• Japanese equities are relatively lowly correlated compared to other markets
• Valuations are attractive, with a slowdown already priced in
Bear Points
• Chinese economic slowdown is weighing on cyclical sectors
• Investors should expect downward revision to consensus earnings estimates
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