Asian markets, and particularly Japan, could be one of this year's equity hotspots. Abe's loose policy mix, the implementation of corporate tax reform and the Shunto wage negotiations were all key catalysts. Lyxor ETF explains why the case for Japan is still intact.
Japanese equity ETFs enjoyed their best ever start to a year with inflows of over €2bn by the end of February, but the wheels fell off as the markets turned - and the market was down 4% in the year to 16th March
Last week, big Japanese companies agreed to raise wages for a fifth successive year after the Shunto - the spring wage negotiations between employers and enterprise unions - concluded. Away from giants like Toyota and Honda, most companies fell shy of the 3% increase targeted by PM Abe and BoJ Governor Kuroda despite tight labour market conditions and historically high profit margins.
The outcome of this year's negotiations should still help to help drive up domestic consumption, but the rate of wage growth won't be enough to clear the hurdles hampering the BoJ's attempts to scale back stimulus. The combination of a negative corporate savings rate and strong wage growth driven by productivity gains - which could draw the deflation era to a definitive end - remains elusive.
Kuroda keeps loose
We expect the BoJ to keep policy loose as it strives to hit the 2% inflation target. Its next move may not come until mid-2019, when we expect it to raise its long-term yield target. Yields will therefore be suppressed for a while yet, so JGBs shouldn't be part of the global trend of rising yields. This should help keep some downward pressure on the yen.
One of the main objectives of "Abenomics" was to strengthen corporate profitability. Six years in and it appears to be working. Sales and profit margins are at their highest levels ever. The country's potential growth rate has increased from around 0.8% in 2012 to around 1.1% - and preparations ahead of the 2020 Olympics in Tokyo should help investment activity pick up speed.
For the first time in a long time, nominal GDP growth is surpassing long-term yields. To us, this says Abenomics policies have not only helped to weaken the yen and strengthen the economy; they have also delivered at least some of the promised structural reforms. The power to support is now greater than the power to suppress. Economic equilibrium is evolving.
Loose policies and further structural reforms remain likely, with the government set on defeating deflation and increasing productivity by 2020. They've already announced programmes designed to enhance social security and education, as well as to increase public infrastructure spending. Investment over the next three years should be more intense in an effort to revolutionise productivity and human resource development.
Further structural shifts - including deregulation and labour market reform - should prompt productivity gains, lift the potential growth rate and make it easier for companies to sustain their profitability.
For all the talk of shift and change, stability matters too. Thankfully, for investors, Abe is likely win in the LDP leadership election this September.
What it all means
Japanese equities have been among the worst of the major equity markets since the start of the year (in local currency terms) getting caught up in the general turbulence and dragged down by lower corporate earnings growth expectations and a stronger yen. But, with the economy on the mend and the BoJ keeping loose, Japanese equities look attractive to us.
We're backing them to recover given progress towards reflation and continued profit growth. They are also less sensitive to the yen than perception has it, especially now domestic demand-led growth is gaining traction.
The road ahead won't necessarily be smooth - short-term headwinds include a looming end to the loose policy era, possible protectionism and geopolitical risk. Adding some protection of your own may not go amiss. Knowing what you're exposed to matters more at times like this Patience could however pay-off and we're still very positive on the long-term outlook.
Investing in Japan
When it comes to choosing your investment vehicle, our analysis could help. In our report at the end of September last year, we found that 44% of active managers outperformed their Japan equity benchmarks over the preceding 12 months. That number drops sharply to 16% over 10 years. It seems that passive tends to win out in the land of the rising sun.
At Lyxor, we have a range of simple Japanese exposures you can choose from - among them some of the largest and most efficient you'll find**. You can also look to our SG Quality Japan income product for more defensive, domestic-oriented exposures.
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Source: All data & opinion Lyxor IAM, Lyxor Cross Asset Research, ETF Research & Lyxor Equity ETF teams as at 15 March 2018 unless otherwise stated. Past performance is no guide to future returns. ** Data over one year as at 31/01/2018. ** Efficiency data is based on the efficiency indicator created by Lyxor‘s research department in 2013. It examines 3 components of performance: tracking error, liquidity and spread purchase/sale. Each peer group includes the relevant Lyxor ETF share-class and the 4 largest ETF share-classes issued by other providers, representing market-share of at least 5% on the relative index. ETF sizes are considered as an average of AUM levels observed over the relevant time period. Detailed methodology may be found in the paper ‘Measuring Performance of Exchange Traded Funds' by Marlène Hassine and Thierry Roncalli. Statements refer to European ETF market. Past performance is no guide to future returns.
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