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Sitting out the summer gloom

Plagued by fears of looming recession, investors in Japanese equities are now playing a waiting game. The reforms outlined by new prime minister Junichiro Koizumi have given the market hope that longstanding problems, particularly in the banking sector, could finally be resolved. But weak economic data are keeping the mood nervous.
In mid-June, finance minister Masajuro Shiokawa said that the government would not reveal details of its planned economic reform until after this summer’s parliamentary elections. Market participants are focusing their hopes on a large-scale injection of public money into the country’s financial sector, which is still weighed down by non-performing loans.
The prospect of political action is offering some support for equities prices but from a fundamental perspective, the economic picture does not look bright. Gross domestic product in Japan shrank by 0.2% between the last quarter of 2000 and the first quarter of 2001.
Industrial output is low, with exports to Europe and other Asian countries remaining weak. However, there are other sectors of the economy that give more reason for optimism, economists say.
“The manufacturing sector will probably continue to have a hard time,” says Kyohei Morita, economist at Nomura in London. “But you can find a different picture if you look to the non-manufacturing sectors. There is continuous growth, albeit slow.”
In the first half of the current fiscal year, the negative contribution from the manufacturing sector will mostly be offset by non-manufacturing business, he says.
However, positive impulses should start coming from the international scene later this year. “We assume in our forecast that the US economy will start to right itself, probably starting in the July–September quarter,” says Morita.
“I don’t see the Japanese economy moving towards a serious recession, but the story could be different depending on what prime minister Koizumi does with regard to the structural side of the economy.”
Two major tasks facing Koizumi – although positive for the economy in the longer term – are bound to have a significant negative impact on the current year’s GDP. He is trying to reduce new issuance of central government debt by ¥3trn and is also attempting finally to resolve the problem of non-performing loans.
An injection of public money into the banking system is the best way of solving the bad debt issue, says Yukiko Kawamoto, head of Japanese equities at HSBC Asset Management in Tokyo. “Generally speaking, financial markets react to that sort of method positively,” she says.
Nick Reid, investment manager at Gartmore in Tokyo, predicts a quiet summer for the Japanese equities market. “Economic data has been a lot weaker than expected. People are trying not to use the R-word, but I think we’re certainly going to have a technical recession.”
Corporate profits remain under pressure, despite earlier expectations from companies that earnings would bounce back in the second half. That now seems unlikely to happen, says Reid, particularly with the current lack of support from the US economy. “As the year progresses, people are going to be reducing their earnings forecasts for the current year.”
Disappointments on the earnings side will not be the only damper on the market’s mood. The supply and demand situation in the equities market is poor, and this is exacerbated by continued moves by the banks to unwind their crossholding positions, says Reid. On top of this, the market will have to accommodate at least two large IPOs later this year, he says.
However, assuming what the market is experiencing is no more than a spell of negative sentiment, now could be a good buying opportunity. Kawamoto says depressed market valuations mean that Japanese equities are now cheap relative to other assets.
“We don’t have much hope for a macro-economic recovery, but there won’t be a crisis – although market valuations are set almost as if it is crisis time,” she says.
Consumer demand is patchy with demand for luxury goods remaining relatively robust. But this demand will inevitably weaken. Koizumi has said that restructuring Japan’s economy will lead to more than a million job losses, and wages are generally not rising. Part-time work and overtime work slowed in the past two months, says Reid.
All factors considered, he predicts Japanese stock prices will be flat in the short term – over the summer – possibly rising slightly after that.
Kawamoto says the market is likely to remain in its current trading range, with the present level being close to the bottom of that range. “There may be upside from here of about 15 or 20%, so it is volatile,” she says.
For investors who view this weakness as a buying opportunity, Kawamoto says that, broadly speaking, she favours equities in domestic sectors. “These will be the beneficiaries of low interest rates.” The investment banking sector has the best prospects, she says.

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