Structural reforms in Japan haven’t come as expected, causing a negative effect on the Japanese equity market.
Immigration, labor mobility and incentives for businesses to invest remain among the most pressing reforms needed.
The economic news in Japan hasn’t been all negative, as there have been several signs of improvement.
By Brent Bates
The Japanese equities market is still negative this year, as the structural reforms promised in the country are not matching last year's hype. The following is a brief review of what we saw in Japan last quarter and how we are responding to the country's economic challenges.
We believe the following economic events have been negative for the Japanese economy:
- Gross domestic product (GDP) expectations are being revised down, as export growth has not increased, and the domestic economy has not improved to the extent that investors had hoped.
- The earnings tailwind from the weakening yen has faded, as the lack of additional monetary stimulus has caused the yen to stabilize.
- Japanese consumers are facing a difficult situation, as inflation has risen faster than incomes and the consumption tax hike has further reduced their purchasing power. What's more, there is likely to be another consumption tax hike in 2015.
Signs of improvement
To be sure, the news from Japan isn't all negative. Among the signs of improvement we see include the fact that:
- Institutional investors are adopting the stewardship code, a broad set of principles designed to help institutional investors show their intent to provide good corporate governance through such measures as the disclosure of stewardship policies, the monitoring of and engagement with investee companies and managing conflicts of interests.
- There has been an uptick in the number of share buyback announcements in the country.
- There is some progress on getting outside representation on the boards of directors of Japanese corporations.
- The Japanese government is setting up some special economic zones.
- The Nikkei 400, which is the new return on equity (ROE)-based index, has garnered some attention.
While it's nice to see such improvements, they alone are not enough to lift Japanese competitiveness and corporate profitability to global levels.
The talk of reform in Japan has been grand, however, we believe that action has been limited in areas that need it the most - immigration, labor mobility and incentives for businesses to invest. Reforms in those areas are necessary, yet progress remains stagnate.
With Japan's weak performance year-to-date, we have used the opportunity to increase the weighting in some of our existing holdings by 90 basis points in the second quarter and 200 basis points year-to-date in Invesco International Growth Fund. Overall, we remain significantly underweight in the country.
With the market trading at a forward price-to-earnings (P/E) multiple of 14x - which represents a premium to Asia overall in return for lower ROE and slower long-term growth prospects - we do not believe this justifies a meaningful shift to our positioning.
The Nikkei 400 is a price-weighted average of 400 top-rated Japanese companies listed in the first section of the Tokyo Stock Exchange. An investment cannot be made in an index.
Return on equity (ROE) is net income divided by net worth.
A basis point is a unit that is equal to one one-hundredth of a percent.
The price-to-earnings (P/E) ratio, the most common measure of how expensive a stock is, is equal to a stock's market capitalization divided by its after-tax earnings over a 12-month period.
The risks of investing in securities of foreign issuers, including emerging market 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.
The Invesco International Growth Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.
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