Years of lacklustre growth, the US-China trade war and a rise in the consumption tax are overshadowing the reasons to be optimistic on Japan, according to Fidelity Personal Investing’s Jonathan Wright. 
Japan was the world’s second largest economy in the 1980s and its fast pace growth meant that it looks set to overtake the US as the biggest. This never panned out: decades later it has slipped into third place, is struggling to expand and is saddled with a heavy debt burden.
But Fidelity Personal Investing senior manager Jonathan Wright believes that Japan has plenty of positives that are being ignored by most investors.
“Much has been said about the country’s unfavourable demographics as it faces the challenge of a low birth rate combined with rising longevity rates,” he said.
“However, Japan is fighting back. Six years ago the Japanese central bank launched a huge stimulus programme, while prime minister [Shinzo] Abe’s ‘three arrows’ policy of monetary easing, fiscal stimulus and structural reforms are all focused on turning the stagnant economy around.
“Looking on the positive side, the unemployment rate, which has risen slightly, is still near to its all-time low, consumption is strong and wages are rising.
“The Japanese domestic economy is also getting a significant boost from an explosion of inbound tourism, mainly from China and South Korea. The number of overseas tourists to Japan has grown in less than a decade from around 5 million to perhaps 40 million next year, as the Tokyo Olympics in 2020 provide a welcome boost.”
Performance of Japan vs global equities over 20yrs (in local currency)
Source: FE Analytics
One important element of these positives is the ultra-loose monetary policy from the Bank of Japan. Interest rates in the country are already in negative territory at minus 0.1 per cent and the central bank has hinted that it is willing to cut them further to get closer to its inflation target of 2 per cent.
Furthermore, the country has proved to be much more resilient to the side effects of the US-China trade war than many expected. The Japanese economy is heavily exposed to global trade and the chilling effect of the dispute was feared to pose a significant risk but real GDP grew by 2.3 per cent in the first half of 2019 – ahead of forecasts and better than the than the long-term potential.
Wright also argued that “key to understanding the likely path of Japan’s economy over the next year” is the rise in the consumption tax that took place at the beginning of October. The hike, from 8 per cent to 10 per cent, could cause growth to slow this quarter but some believe that the worries about its impact are overdone.
Performance of Japan vs global equities under Shinzo Abe (in local currency)
Source: FE Analytics
When the consumption tax was last raised five years ago (from 5 per cent to 8 per cent), it prompted a 7.3 per cent reduction in Japanese GDP. However, this was largely down to the fact that many expected to second part of the increase, to 10 per cent, to be implemented soon after.
As it was, the second increase was pushed back several times to this year and this offsetting seems to have cushioned the blow: the consensus estimate is that the recent hike will knock just 2.7 per cent off GDP.
“Factoring all of this in, an optimistic outlook is not reflected in the price of Japanese shares,” Wright concluded.
“For a long time Japanese shares have been out of favour and as a result valuations are approaching historical lows, especially when compared to the US where the S&P 500 has just hit an all-time high.
“As ever, stockpicking will be key in such a market. Investing in a managed fund leaves the decisions to experts who search for opportunities in Japan, only choosing the companies they believe have the potential to perform strongly.”
Fidelity has three Japanese strategies on its list of preferred funds.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The first is the £3.1bn Baillie Gifford Japanese fund, which is headed up by Matthew Brett. Wright said its portfolio is positioned to capitalise on Japan’s competitive advantages in sectors like automation and robotics.
Man GLG Japan CoreAlpha, which is managed by Stephen Harker, Neil Edwards, Jeff Atherton and Adrian Edwards, has recently been added to Fidelity’s list. The £2bn fund has a contrarian approach that can led to periods of underperformance but it has a strong long-term track record.
The final option Wright thinks investors should consider is Michael Lindsell’s Lindsell Train Japanese Equity fund, which has a very strict investment approach that sees it buy quality companies and hold them for the very long term.