Abenomic’s – Green Shoots
In late June, Japanese Prime Minister Shinzo Abe told reporters, “A virtuous cycle is appearing in Japanese economy.” JP Morgan’s Head of Japan Equity Research agrees, recently stating, “The private sector getting its mojo back. Consumer spending led the economy last year, now business investment is beginning to pick up. Businesses are retooling their factories, and wage growth is beginning to pick up.” Adding that, “Part time workers represent 40% of all paychecks, and these part-time wages are growing at 6%” driving domestic demand.
Additionally, average land prices for Japan’s three largest cities rose last year, marking the first annual growth since 2008. Real estate transaction volume rose 70% from 2012 to 2013. The 3% sales tax hike in April has created noise in the Q1 and Q2 economic data, but it is important not to get caught in the noise as Japan appears to be exhibiting sustainable economic acceleration. Many economic indicators saw a spike before the April tax hike as demand was pulled forward from future months into March. This has resulted in a May and June drop in economic activity relative to March and April. The noise in economic data should level out going into Q3. Despite the noise, Japanese equities appear to be in an attractive position. Similar to the set up for U.S. Equities around the announcement of QE2, either the economy surges from here and equities rally, or the economy stalls and more aggressive Abenomics is applied, and equities rally.
Valuations & Fundamentals
Japanese equities, as defined by the MSCI Japan Index, are attractive on an absolute and relative basis. Out of a universe of 32 countries, Japan has the 5th lowest price to book ratio (1.23x) and the 8th lowest price to cash earnings ratio (7.20x). Relative to history, Japan has the #1 ranked value profile. Japan’s current P/E ratio is 10.4x lower than its 5 year average P/E ratio. Furthermore, Japan’s forward P/E multiple is trading at a 10.6% discount to the MSCI World, the largest discount in 20 years.
Meanwhile, growth fundamentals in Japan are strong and have room to strengthen further. Out of 32 countries, Japan has the #1 ranked earnings per share trend and the #2 ranked year-over-year growth in earnings.
Importantly, there appears to be room for growth fundamentals to improve. The Brookings Institute estimates that the Japanese economy has an output gap of 4% to 10%. An output gap is the difference between a country’s potential growth and actual growth. The effects of Abenomics are believed to have closed this gap by 1%, leaving a meaningful gap still left to be closed. Furthermore, Japan’s return on equity, a key fundamental indicator, appears to have bottomed. The ROE of the MSCI Japan index currently rests at 8.46%, 28th ranked out 32 countries. While this ROE level is low relative to the rest of the world, Japan’s ROE trend is impressive and there appears to be room for a continuation of this trend.
Price Momentum & Share Buy Backs
The MSCI Japan Index (hedged for JPY currency risk) is up 8.4% since May 21st. This rally occurred after selling off more than 12% between January 1st and April 14th. Additionally, Japanese companies bought back US$2 Billion worth of shares in in Q1 2014, a 54% increase from Q4 2013 and a strong sign of attractive valuations and earnings growth.
From a longer term perspective, we may have seen a secular low in Japanese valuations and equity performance in late 2012. The Price to Book Value Ratio of Japan’s TOPIX Index contracted from 4.4x in December 1989 to 0.88 in September 2012. Over this same time period, a currency hedged U.S. Investor in Japanese equities experienced a 75% loss. Since September 2012 the Price to Book Ratio of the TOPIX Index has expanded from 0.88 to 1.23, while gaining 80% through the end of 2013. After some momentum consolidation in early 2014, this theme looks poised to push higher on the back of unprecedented government accommodations and a blend of attractive valuations and improving fundamentals.
Sources: Bloomberg, Accuvest Global Advisors, Brookings Institute
Disclosures:
This article was written by James Calhoun, a Portfolio Manager at Accuvest Global Advisors (AGA). This article is strictly informational and should be used for research use only. It should not be construed as advertising material. The opinions expressed are not intended to provide investing or other advice or guidance with respect to the matters addressed in this brochure.