Market rally backed by corporate earnings growth and low inflation


Fund Commentary
26 Jan 2018


In December, Japanese stocks generally rose. Foreign investors who invested heavily during September and October however appeared relatively quiet throughout the month. Small cap stocks followed their 2017 trend and continued to rise. Throughout the year, the Topix (containing 2,000 companies out of a total of 3,600 listed companies in Japan) rose 20%, whereas the Jasdaq (containing 749 smaller companies) increased 43% during the same time period.

Generally, small cap stocks outperformed large cap stocks in 2017; however, the Jasdaq currently trades at a P/E of 24x and a PBR of 1.7x, thereby not being too dissimilar from the Topix, trading at a P/E of 17x and a PBR of 1.5x respectively.

The year proved to be a remarkably good year for equity markets. The Investment Adviser perceives the reason for the equity market’s rally to be robust corporate earnings growth, low inflation and a stable government in Japan.

The team expects the current macro environment and political stability to persist for some time, with the possibility of Japanese companies being able to generate 5% – 10% profit growth in 2018. The Investment Adviser thinks, that those, who had previously complained about an aging society and a decreasing population in Japan may in fact realise that the country can still compete with other nations given its labour force and business ideas.

Throughout 2017, a total of 93 companies IPOed in Japan, with the Investment Adviser expecting similar numbers in 2018. Against this backdrop and in anticipation of moderate corporate earnings growth, this will give the team plenty of new opportunities.

In December, the Investment Adviser reduced the Fund’s exposure to several electronic stocks and those that have performed strongly, locking in profits. Since inception in March 2017 the Fund has returned strong absolute performance of 28%, outperforming its benchmark by 10%. The team will maintain the current portfolio and its research approach in 2018, continuing to target superior returns.

Japan Material (6055), the Fund’s largest contributor to performance in December, provides gas management system services for semiconductor and liquid-crystal factories. The Company also develops and makes application software products for CAD/CAM and 3D data processing. Over the last few years, the bottom-line of the Company has grown around 15 to 25%, backed by strong global investments in semiconductor manufacturers and in combination with continuously receiving maintenance service orders from existing clients. The Company develops its applications and software for gas management systems internally, generating a higher profit margin. Japan Material currently trades at a P/E of 43.1x, a PBR of 8.7x and a ROE of 21.9%.

The views and statements contained herein are those of Rheos Capital Works Inc in their capacity as Investment Adviser to the Fund as of 12/01/18 and are based on internal research and modelling.