Economic Weakness May Bring New Opportunities In Japan

|
Includes: DBJP, DXJ, EWJ, EZJ, NKY
by: Invesco US

Summary

We believe it will be difficult for Japan to achieve real economic growth after losing two decades to stagnation, given the changes that will be required.

We are finding select opportunities in Japan now that valuations are cheaper than they were earlier in the year.

Although valuations are cheap, lower expected returns and profitability vs. the broader international market continues to keep us cautious about Japan.

By Mark Jason

Last year, Bank of Japan Governor Haruhiko Kuroda made a pledge when he came into office to "make an all-out effort" to improve the Japanese economy. Investors were quick to react positively to this declaration, despite the risk of failure that we saw.

Such "gung-ho" investors, who were the big winners in last year's rally, have since pulled back, and the risk that Prime Minister Shinzō Abe's economic plan may not work sufficiently is slowly being priced in.

In the past, we've stated that breaking free from two decades lost to stagnation is a difficult challenge for Japan, as we believe that achieving real economic growth requires changes that are very difficult and hard to come by. In fact, our team continues to believe this, as evidenced by the underweight in Japan (relative to benchmark index) across several of our funds. (Invesco International Growth Fund (AIIEX) = 6% vs. MSCI All Country World ex- US Growth Index = 14%; Invesco Global Growth Fund (AGGAX) = 4% vs. MSCI All Country World Index = 7%)

As we communicated in a blog post earlier this year, our team passed on Japanese companies in the fourth quarter of 2013 in favor of other companies in the Asia-Pacific region that more closely adhered to our EQV (earnings, quality and valuation) criteria.

Opportunities

However, now that Japan is cheaper than what it was at the beginning of the year, we're finding selective opportunities.

For example, in the first quarter, we added Japan Tobacco (OTCPK:JAPAF), the world's third-largest cigarette manufacturer, excluding China. (0.74% of Invesco International Growth Fund). Japan Tobacco is attractively valued considering it has the prospect of improving profitability, particularly in emerging markets, which account for about one-third of the company's sales. We also see improving shareholder returns through potential buybacks and dividend increases.

Headwinds

Despite our interest in Japan Tobacco, overall, we believe there are reasons to still be cautious about Japan:

  • Japan has lower expected returns with similar valuations in comparison to the rest of the world: The return on equity for the MSCI Japan Index is less than 10% versus nearly 15% for the MSCI All Country World Index, while price-to-earnings ratios for those two indexes are roughly equivalent - at about 13x.
  • EBITDA margin, which measures profitability, for the MSCI ACWI ex-U.S. Index is nearly 24% versus only 16% for the MSCI Japan Index.

Key takeaway

Although Japan is a large and important equity market, we continue to remain underweight while pursuing select opportunities that adhere to our EQV criteria mentioned above.

Holdings are subject to change and are not buy/sell recommendations.

The MSCI Japan Index is an unmanaged index considered representative of stocks of Japan. The MSCI AC World Index is an index considered representative of stock markets of developed and emerging markets.

About risk

Depositary receipts involve many of the same risks as a direct investment in foreign securities, and issuers of certain depositary receipts are under no obligation to distribute shareholder communications to the holders or to pass through to them any voting rights with respect to the deposited securities.

Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.

An investment in emerging market countries carries greater risks compared to more developed economies.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.

The investment techniques and risk analysis used by the portfolio managers may not produce the desired results.

Stocks of medium-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

Preferred securities may include provisions that permit the issuer to defer or omit distributions for a certain period of time, and reporting the distribution for tax purposes may be required, even though the income may not have been received. Further, preferred securities may lose substantial value due to the omission or deferment of dividend payments.

NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
Click to enlarge

Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their advisors for a prospectus/summary prospectus or visit invesco.com/fundprospectus.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is a U.S. distributor for retail mutual funds, exchange-traded funds, institutional money market funds and unit investment trusts.

Invesco unit investment trusts are distributed by the sponsor, Invesco Capital Markets, Inc. and broker dealers including Invesco Distributors, Inc. These Invesco entities are indirect, wholly owned subsidiaries of Invesco Ltd.

©2014 Invesco Ltd. All rights reserved.

blog.invesco.us.com

Disclosure: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.