Industry Voice: Japanese equities retain the characteristics that can continue to work well in 2019.
Global investors' risk appetite was tested by various factors in 2018, including rising U.S. interest rates, a slowing Chinese economy, and a breakdown in U.S./China trade relations. Amid this backdrop, Japanese equities, along with most other major markets, ended the year in negative territory. The pullback also reflected a narrower market leadership, with fewer stocks posting positive returns as the near‑perfect conditions for equity markets in 2017 faded.
However, we believe that Japanese equities retain the characteristics that can continue to work well in 2019, supported by a stable economy and positive, although slowing, global growth. Japanese equity valuations are below their long-term average, companies are delivering positive earnings growth, and structural market reforms should also prove supportive of rising corporate returns.
Slower, Stable Growth Remains Supportive
While the broad outlook remains favourable, headwinds are rising, and we anticipate a slowdown in global growth momentum in 2019. Although Japan is more than a cyclical story, the global economy remains a key influence on the equity market. The main risk from the global economy stems from the ongoing U.S./China trade dispute. Japan's manufacturing and technology sectors stand to lose in the event of any significant disruption to Asian supply chains.
Locally, the decision to increase the consumption tax in 2019—while welcome in terms of long-term stability—has the potential to undermine near-term growth. We anticipate further stimulus measures over the coming year as the government attempts to mitigate the impact of the sales tax hike.
More broadly, the Bank of Japan (BoJ) continues to affirm its accommodative policy stance. While inflation data have increased recently, current levels of inflation, and wage growth, remain shy of BoJ targets.
Favourable Equity Fundamentals
Despite the possibility of slower global growth in 2019, the fundamental equity story in Japan remains intact. Attractive relative valuations; solid earnings growth; and, perhaps most significantly, improvements in corporate governance give us reason to be positive about the outlook for Japanese equities in 2019.
Capital spending data also suggest that Japanese companies are using their cash more efficiently. This raises the prospect of Japanese equities being positively rerated in 2019 as a result of improved returns on equity. Share buyback activity and higher dividend payments are also expected to remain a feature of the market, providing near-term support for equity markets.
Abenomics and the Impact of Reforms
We are six years on from the launch of the "Abenomics" market and economic reform strategy, and the accomplishments have been considerable. Some of the key achievements, to date, include:
- Unemployment is at a 25-year low, with a sharp rise in female participation in the workforce
- The fiscal deficit has been halved
- Deflationary risks have reduced
- Corporate cash generation is at an all-time high
- Corporate governance standards have been raised
The improvement in governance standards is particularly noteworthy. Corporate governance and stewardship codes have been implemented with speed and determination, designed to encourage a more robust and globally competitive business environment.
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Archibald Ciganer is the portfolio manager for the Japan Equity Strategy, having previously covered the telecom, transportation, utility, media and consumer sectors as a research analyst in the Equity Division.
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