Japan has been the stand out equity market of 2013, rising 50% in Yen terms during 2013. We explain the reasons for our continued interest in this equity market despite these gains having already been recorded.
• Valuations on the Japanese market remain attractive. Although the market is up approximately 50% YTD, earnings per share have increased by 36%, so in price earnings terms the market is not much more expensive than at the beginning of the year. The PE ratio has actually declined from 18.0x to 16.8x. When looking at asset values the price to book ratio in Japan is 1.27, which has risen from 0.9x a year ago. This compares very favourably to the US equity market that trades at 2.6x price to book.
• As the world continues to heal after the stresses of 2008, we can expect a normalisation of US interest rates to equate to higher US bond yields. We expect this will drive the US dollar higher against the Japanese Yen over the medium term. A weaker Yen is likely to be bullish for the Japanese stock market, with its high degree of earnings from exports overseas.
• Japan is one of the few economies in the world that would welcome higher inflation and indeed inflation is a mark of success of their policies. While the rest of the world has to deal with the headwinds of higher inflation and probably interest rates, Japan will benefit from the reflationary effects of unlocking savings after years of falling prices.
• Japan has little choice but to stick with its current plans. The fiscal position in Japan has deteriorated to a point at which something needs to be done. Gross and net debt is currently 210% and 140% respectively, significantly worse than its OECD partners. Up until now Japan has not had to rely on foreigners to buy it debt, it appears that this may now be changing.
• In 2000 China had an economy one-fifth the size of Japan, now China’s economy is more than 60% bigger than Japan’s. The fear of being further eclipsed by China is giving Japan a reason to act now. The rivalry between the two nations is well documented and many in Japan think this is their last chance to act in order to be able to hold their own against their now larger and powerful neighbour.