Despite a difficult year, the Japanese economy should expand in 2018 with companies well-positioned amid a slowdown in other parts of the world, according to Invesco Perpetual’s Paul Chesson.
Chesson, who is head of Japanese equities and runs the £311.9m Invesco Japan fund, said while positive, 2018 growth will likely be slower than last year.
The manager noted that disruption caused by extreme weather including Typhoon Jebi – the strongest for 25 years – floods, and extreme heat has posed plenty of headwinds for the economy.
“After a weak start to the year, the economy remains on a broad improvement trend supported by healthy levels of corporate spending and a high demand for labour, which is leading to slightly faster wage growth, together with a generally supportive global environment,” the Invesco manager said.
Performance of Japanese GDP over 5yrs
Source: Organisation for Economic Cooperation & Development
However, he warned that while there are reasons for remaining optimistic in the near term a number of headwinds continue to face the Japanese market.
“Growth appears to have hit a soft patch in some economies, in particular China,” he explained. “We are also in a rising US interest rate environment, which carries some risk.”
Another challenge for the domestic economy is the increase in consumption tax scheduled for October 2019, which will rise from 8 per cent to 10 per cent.
“However, our recent contact with companies that are highly sensitive to global demand suggests that growth conditions remain robust, with no signs of a slowdown so far.”
Indeed, the Invesco manager noted that Japanese companies expect to deliver pre-tax profit growth of around 5 per cent for the fiscal year ending March 2019.
“Companies’ own guidance looks cautious, with recent yen weakness likely to boost full year profit figures compared to current expectations,” he said.
Chesson said there were several reasons why the outlook for the Japanese economy “remains quite positive”.
“Japan is making slow and gradual progress in its fight against deflation,” he explained. “Wages have been rising, but at a modest rate, and core inflation is still below 1 per cent.
“However, the Bank of Japan remains committed to lowering interest rates and increasing monetary supply through quantitative easing, a policy stance that is not expected to change in the foreseeable future and which should help keep the yen competitive relative to the US dollar.”
This should, said Chesson, be supportive for both the broader economy and for corporate earnings.
Performance of Japanese yen vs US dollar YTD
Source: FE Analytics
As the above chart shows, the Japanese yen has fallen by just 0.93 per cent against the US dollar this year, so far.
One area of concern that has riled Asian markets more recently – and could impact Japan – is the ongoing trade spat between the US and China.
“It is very difficult to quantify this kind of political risk, which highlights the importance of focusing on company-specific fundamentals and valuations,” said the Invesco Japan manager.
“It is also important to remember that some companies in Japan could actually see some benefits.”
Indeed, Japanese car manufacturers could be one of the indirect beneficiaries of the so-called trade war given the number of cars exported to China, which could benefit as import tariffs are reduced, said Chesson.
Meanwhile trade discussions between the US and Japan are expected to be formalised early next year and, while the risk of tariffs risks remain, have so far been constructive.
The fund manager said the large local presence of the Japanese carmakers in the US also provides some leverage in the negotiations.
Another positive for the Japanese market is that corporate management has remained conservative meaning that there is the potential for companies to start deploying large piles of cash that has been sitting on balance sheets.
“Corporate confidence remains upbeat, with plenty of opportunity for companies to update existing production capacity, or invest in new facilities,” the manager explained.
“There is also potential for further growth in buy-backs and dividends, which have remained on an upward trend in recent years, with [bank] Mitsubishi forecasting that shareholder payouts will reach a record high this year.”
Given healthy conditions in the domestic economy, an accommodative central bank stance and a strong corporate backdrop, the manager has positioned the fund in more economically-sensitive areas of the market, adding to those names most sensitive to global growth.
He explained: “This is where we are able to find the most attractive valuations, which stand in marked contrast to more growth-oriented areas of the market, where we believe valuations in many cases look stretched.”
As such, the fund’s largest sector weighting is to manufacturing, making up 41.57 per cent of the portfolio, while finance and insurance names represent a further 23 per cent.
The biggest stock position is Sumitomo Mitsui Financial representing 6.25 per cent of the portfolio, while another financial name – Mitsubishi UFJ Financial – makes up 6.21 per cent. Honda Motor, at 6.16 per cent of the fund, rounds out the top-three.
Chesson joined the fund in February 2000 and manages the portfolio alongside Tony Roberts.
Performance of fund vs sector & benchmark under manager
Source: FE Analytics
Under Chesson, it has delivered a total return of 74.64 per cent compared with a 54.98 per cent gain for the TSE Topix index and a 30.48 per cent return for the average IA Japan fund.
The fund has an ongoing charges figure (OCF) of 0.93 per cent.