by Patrick Moonen, senior strategist multi asset, at NN Investment Partners
The best performing market year to date is Japan. The region fits investor preference for markets offering superior earnings growth, accommodative monetary policy, a high equity risk premium, with the prospect for structural reforms and better corporate governance.
Earnings revisions are positive and earnings growth is not only driven by a weaker yen and higher economic growth, which are cyclical elements, but also by structural changes in corporate behaviour. Pushed by top-down institutional forces, a behavioural shift is happening in Japanese companies. The focus is on shareholder value. Amongst important new rules: the Corporate Governance Code effective from June encouraging companies to set return targets and explain strategic rationale of cross shareholdings, the Japan Stewardship Code encouraging investors to become more vocal, and tax reforms aimed at steering the effective use of capital. The first effects are already visible in the form of higher share buy backs and dividends. In 2014 these rose to 12 trillion JPY, double the level paid out in 2009 and a new record high. Over time this will lead to a more ‘Western’ level of ROE and a higher price to book ratio.
In the meantime Abenomics continues to make progress helped by the fact the Liberal Democratic Party (LDP) is on firmer footing to push through structural reforms. Regional elections in April confirmed the LDP as the only dominant force in the current political landscape. Bills submitted during the current parliament session aim to lift the growth rate of the Japanese economy to a structurally higher level.
The BoJ from its side is ready to intervene if and when necessary. Inflation has been undershooting expectations and the BoJ has already pushed back the expected timing of reaching a 2 percent-target from FY2015 to FY2016 H1. Without additional easing its commitment to achieve the inflation target may start to be questioned by market participants.
Another argument is valuation. The Japanese equity risk premium is 4.8 percent which is 1.6 standard deviations above its long term average and 0.5 percent above the global average. On a price to earnings basis, the Japanese and European markets are similarly valued. However, corrected for the different sector composition, Japan trades at a 12 percent discount with only two (Utilities and Health care) out of 10 sectors more expensive than in the Eurozone. On price to book, Japan is even 27 percent cheaper but this is of course linked to the lower ROE-levels of Japanese companies (6.8 percent versus 8.9 percent in the Eurozone). As stated earlier we believe that Japan will gradually close the gap with the other regions thanks to structural behavioural changes.
Finally, price and flow momentum is positive. So, all in all more than enough reasons to stick to our overweight and even add to it.
