The Japanese economy is recovering after temporary and technical stagnation in 2Q and 3Q 2014

By Yutaka Uda

Fund Commentary
31 Dec 2014

By Yutaka Uda

In November, Japanese markets continued to rally triggered by two announcements on 31st October: the BOJ’s announcement on further monetary easing and the GPIF’s decision on the increase in weightings for Japanese equities. The market dipped at one point mid-month in response to the negative numbers on Jul-Sep real GDP growth, however recovered quickly after Prime Minister Abe announced a snap election and the postponement of the second consumption tax increase from Oct 2015 to April 2017. The Nikkei 225 Index closed the month at 17,459.9 (up 6.4% MoM) and the TOPIX at 1,410.3 (up 5.8% MoM). This is the highest level we have seen in approximately 7 years.

In terms of sector performance, of the 33 TSE sectors, 21 appreciated. The best five performers were textiles, marine transportation, air transportation, rubber and transportation equipment. The worst five performers were mining, oil, real estate, communications, and pharmaceuticals.

At the beginning of November Japanese markets continued the rally that started from the end of October. The BoJ’s decision on further monetary easing prompted speculation for a widening interest rate gap between the US and Japan and triggered the yen to weaken further against the dollar. This also supported the rally in Japanese equities. In mid-November, the release of disappointing domestic numbers dragged on the market, however Abe’s decision to call a sudden election and the postponement of the consumption tax increase quickly enabled the market to recover. Subsequently the yen depreciated against all other major currencies, but in particular the US dollar as, following the US mid-term elections where the Republicans gained majority in both the House and the Senate, this brought expectations for stimulus in financials and business entities within the US. The yen started the month at 112.32 against the USD and depreciated towards 118.63 JPY /USD by the end of the month. The market ended the month in a high price range.

The net asset value per share for the Nippon Growth (UCITS) Fund on a Japanese Yen basis as of 28 November increased 4.7% compared with that of 31 October, while the TOPIX Index increased 5.8% during the same period. The Fund put no new names into the portfolio with no stocks sold out. The Japanese economy is recovering after temporary and technical stagnation in 2Q and 3Q 2014. Industrial production in October rose 0.2% MoM, better than the market consensus of -0.6% MoM, and shipments rose 0.4% MoM with inventory down 0.4% MoM. We’ve already seen clear signs of export recovery in September and October amid a weaker yen and the current commerce data also showed signs that consumer durables such as passenger cars and home appliances are bottoming out. The government estimates that industrial production in November would increase 2.3% MoM and rise a further 0.4% MoM in December. The Lower House election will be held on 14 December. It is a bit too early to say what sort of outcome from the election might be. The LDP might lose some seats but should retain the majority rather easily in which case the Abenomics policy would not change basically after the election. But from late December into early next year the government should announce a clear schedule of corporate tax cuts for FY2015 onwards and also discuss the subject of the supplementary budget for FY2014 in order to secure getting out of deflation and achieve high growth. Mr Abe might focus more on economic stimulus in 1Q 2015 ahead of local elections next spring. The Japanese yen against the US dollar has come down sharply to 120, a technically and symbolically important level. The Investment Adviser believes that the election might be a trigger for a change in the direction for the currency as fiscal policy could reappear as an important role or arrow to reflate the Japanese economy. With the anticipation of a currency in the range of 110-120 JPY/USD in 2015, Japan should have a greater chance of achieving real GDP growth of more than 2% in FY2015 with corporate profits increasing more than 15%. Capital expenditure should grow substantially in the wake of intensifying labour shortage and capacity constraints.

In the past couple of months exporters have been leading the rally but, after the election, the market leaders should become those more domestic oriented, Abenomics related stocks.

Investors should start to look at more fundamental factors such as valuations, business outlook and potential. The market may show another strong increase in 2015 with the TOPIX Index approaching more towards a level of 2000.

The Fund is increasing allocation to the machinery sector with the conviction that capital expenditure (Capex) growth is required in order to facilitate higher productivity. The Fund will maintain a high weighting in banking and the commerce sector (trading companies). On the other hand, defensive and technology sectors should be avoided, as these tend to have high valuations and lower growth potential.

Commentary provided by Evarich Asset Management in their Capacity as Investment Advisers to the Fund as of 09 December 2014