Japanese equities: benefiting from external and internal transformations

Japan has created the largest free trade zone in the world with the EU via the Economic Partnership Agreement. The country is currently undergoing further transformations that offer interesting investment prospects in various industries.

Fund Commentary
6 Jun 2019

Japan has created the largest free trade zone in the world with the EU via the Economic Partnership Agreement. The country is currently undergoing further transformations that offer interesting investment prospects in various industries.

The ongoing trade war between the US and China has had a negative impact on the Japanese economy. Demand for products from Japan declined noticeably, especially from the People’s Republic of China. The USA and China are the most important customer countries for this export-oriented country. According to the latest data published by the government in Tokyo, Japan’s gross domestic product (GDP) forecast for the year from January to March 2019 rose by 2.1 percent despite a 2.4 percent decline in exports. At the beginning of this year, on 1 February 2019, the Economic Partnership Agreement (EPA, also known as Japan-EU Free Trade Agreement or JEFTA) between Japan and the EU came into force, creating the largest free trade area in the world and thus sending an important signal against increasing protectionism. The EPA, which was negotiated over five years in 19 rounds and signed in July 2018 by Prime Minister Abe Shinzo, EU Commission President Jean-Claude Juncker and EU Council President Donald Tusk, provides significant impetus for further stimulation of the Japanese and European economies. Since the EPA came into force, the broad Japanese share index Topix has shown a cautious positive reaction to this development and has risen by three percent to 1,622 points over three months.

For Japan, the third largest economy in the world, the European Union is one of the most important economic zones for trade, exporting in particular goods from the mechanical engineering, automotive, electronics and chemical industries. Japan is the EU’s second most important trading partner in Asia. Almost 74,000 EU companies export to Japan, 78% of which are SMEs. Services account for a larger share than goods. The main exports are pharmaceuticals, medical devices, agricultural products and foodstuffs, motor vehicles and means of transport. Germany is Japan’s most important trading partner within the EU.

What trade arrangements will apply between the EU and Japan following the Economic Partnership Agreement having come into effect? Over the medium term, 94 percent of all Japanese exports to the EU are to become duty-free. Japanese companies are already exempt from 14 percent import duty for electronic devices and 10 percent for cars. For the EU, 90 percent of customs duties on exports to Japan have been abolished. After the expiry of various transition periods, this figure will even rise to 97 percent. Significant progress has also been made on services and non-tariff barriers to trade. The commitment to the Paris Climate Protection Agreement places free trade on a sustainable footing.

Japanese and European companies benefit from the free trade agreement, because the reduction of customs duties and other trade barriers has made it considerably cheaper to export goods and services to each other’s markets. Japanese companies have moderate valuations, record earnings in the first quarter of 2019 and increased transparency thanks to corporate governance reforms. In particular, companies from export-oriented sectors such as car manufacturers or electronics companies are likely to increase sales and profits as a result of the EPA.

Japan is opening up not only to the outside world, but also to the inside. After the accession of Emperor Naruhito to the throne on 1 May, a fresh breeze is blowing through the country. The new era called “Reiwa” will bring changes. As a result, also high-growth companies that offer solutions for domestic challenges can benefit. Demographic development with a homogeneous ageing population and a low birth rate does not ensure sufficient skilled staff for the Japanese labour market. Of Japan’s approximately 125 million inhabitants, only 1.5 million (1 percent) are foreigners. Even if the Japanese government is planning to open the country to foreign skilled workers, the shortage of skilled workers will not been solved for the next few years. Software companies whose products contribute to making workflows resource-efficient offer excellent investment opportunities. The Japanese government also intends to substantially expand tourism. The Olympic Games in Tokyo next year and the World Expo in 2025 should provide excellent opportunities for this. Against this background, companies whose products are in demand by tourists, such as hotels or discount chains, appear to be good investment opportunities. Another interesting investment area is 5G, which will be extended over the next few years. Capital investments in information communication equipment industry has increased by 60 percent in Japan in 2018 and by 40 percent in 2017. In this respect, tech stocks can be a promising investment.

This article first appeared in Börse am Sonntag in June 2019.

The views and statements contained herein are those of Rheos Capital Works Inc. in their capacity as Investment Adviser to the E.I. Sturdza Strategic Japan Opportunities Fund as of 6 June 2019 and are based on internal research and modelling. This does not constitute independent research and under no circumstances should the information contained therein be used as a recommendation to buy or sell any security or financial instrument or service or to pursue any investment product or strategy or otherwise engage in any investment activity or as an expression of an opinion as to the present or future value of any security or financial instrument. Nothing contained in the views and statements by Rheos Capital Works Inc. are intended to constitute legal, tax, securities or investment advice. The views and statements contain “forward-looking statements”. All projections, forecasts or related statements or expressions of opinion are forward-looking statements. Although Rheos Capital Works Inc. believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct, and such forward-looking statements should not be regarded as a guarantee, prediction or definitive statement of fact or probability.

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