Japanese equity markets have disappointed for more than two decades, but in recent years there's been an impressive turnaround. Moreover, the next year or so could also be promising as conditions are in place for a continued rebound, says Stephen Lingard, senior vice-president with Franklin Templeton Solutions, a unit of Toronto-based Franklin Templeton Investments Corp.
For the first two months of this year, the MSCI Japan Index returned 17% as expressed in Canadian dollars. And it's up 23.3% over the past 12 months and an annualized 18.5% over three years.
Lingard's optimism is rooted in several factors, starting with the quantitative-easing (QE) program introduced by the Bank of Japan in 2013, and in particular its unexpected announcement last October that it would raise its monthly bond-buying to 80 trillion Japanese yen, up from 60 trillion yen.
The QE program is one of the three policy "arrows" espoused by Prime Minister Shinzo Abe, father of so-called Abenomics. "Easy monetary policy has been a key driver in the 40% decline in the yen over the last two years," says Lingard. "And that has helped corporate profits to double."
The other two "arrows" are fiscal restructuring and structural reforms designed to bring about much-needed changes to Japan's corporate culture. Fiscal restructuring, which involves creating an inflation target, is proving to be a challenge, not only to establish but also sustain. "We know how difficult it has been for the U.S. Federal Reserve and European Central Bank to achieve," says Lingard. "But this is new territory for the Bank of Japan and proving even more difficult."
Lingard acknowledges that the goals of the third "arrow" -- which include reforms surrounding health care, agriculture, employment, trade and immigration -- are formidable. Lower corporate taxes have been enacted for fiscal 2015 and utilities have been deregulated, for example. But still to come are labour reforms, and most thorny of all is immigration reform. "It will require sheer strength from Abe's cabinet and patience on the part of investors."
Yet on a visit last December to Tokyo, Lingard met a member of the Bank of Japan's policy board, and came away more confident that Japan will try hard to meet its inflation target. A 21-year industry veteran, who earned a BSc from the University of Western Ontario and an MBA from Brussels' European University, Lingard is not a Japanese equity specialist. Rather he calls himself a contrarian investor who is taking a top-down view which focuses on the positive ingredients behind decisions to overweight Japan in several portfolios.
Meeting an inflation target "has a very positive outcome on risk assets," says Lingard, who joined Franklin Templeton in 2007 and works on Canadian-based multi-asset products including the Quotential and LifeSmart Portfolios. "We're investing in assets, not betting on the economy necessarily. My job is to pick markets and assets that could go up in price."
Adds Lingard: "The Japanese are up against a difficult goal, but the Bank of Japan will do anything to create this inflationary environment, so they will be credible in the marketplace. For me, that's very inflationary when it comes to asset prices."
Lingard's conviction is reflected in Franklin Quotential Balanced Growth Portfolio, which has a 60-40 mix of equities and fixed income, and double the Japanese equity exposure compared with the benchmark MSCI World Index. Among other vehicles, Lingard gets equity exposure through WisdomTree Japan Hedged Equity DXJ, a U.S.-dollar-hedged Japanese ETF, and Franklin Templeton Japan, a Luxembourg-registered product.
Part of Lingard's thesis is that Japanese equity prices have not kept up with the improving corporate fundamentals, thus pushing valuations lower. "The market is cheaper on a price-to-earnings basis than before Abenomics began so there is still opportunity for global investors," says Lingard. He expects that corporate profit growth may surprise on the upside and could increase as much as 15% to 20% year over year. "In markets such as the U.S., Canada and Europe, rallies have been driven by multiple expansion and not so much earnings. Japan looks more attractive to us on this basis."
Another factor that Lingard cites is the emergence of Japan's Global Pension Investment Fund (GPIF), one of the world's largest pension funds, as a buyer of domestic equities. "Most of the rally over the past two years has been enjoyed mostly by foreign investors who account for about 60% of exchange volume," says Lingard. "But this is changing more recently. The GPIF has doubled its target to domestic equities to 25%. Deeply negative interest rates encourage people to move out of savings accounts and take on more risk in the economy."
Yet as an investment manager who is mindful of risk, Lingard is agnostic as far as the long-term success of Abenomics is concerned. "If this ultimately fails, equities will discount this. So I have to be ahead of the market in deciding if this ultimately will work. We're tactical investors; we're not buying this for the next five years. We're watching this on a quarter-by-quarter basis."
:quality(80)/cloudfront-us-east-1.images.arcpublishing.com/morningstar/5WSHPTEQ6BADZPVPXVVDYIKL5M.png)
:quality(80)/cloudfront-us-east-1.images.arcpublishing.com/morningstar/Q3KIND5VXRCNHHH6JQHCCYBSSA.png)
