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Impact Investing

IPE special report May 2018

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Land of rising expectations

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The thorough overhaul of corporate Japan is proving itself at last, with clear indications now coming from many companies that their forthcoming profit announcements will give shareholders a pleasant surprise. But strategists say it is the sweeping restructuring measures rather than any sales growth which have boosted profitability.
However just when the picture is finally looking bright for the Japanese stock market, the crushing pressure felt on foreign bourses is keeping a lid on domestic prices.
Although fundamentally, the Japanese economy app-ears sound, there is a danger that the US market could weaken further, says Yukiko Kawamoto, head of Japanese equities at HSBC Asset Management in Tokyo.
The technology-laden Nasdaq in the US has lost around a quarter of its value since the beginning of September. Now sentiment on the US markets is dominated by worries about the potential for war in the Middle East, the oil price and concerns about a rise in the number of defaults domestically. When the US market is weak, this will affect the Japanese market, says Kawamoto.
“Fundamentally, the Jap-anese economy is still on the right track, with recovery continuing in the consumer market... from this side there is no reason to be bearish,” she says.
Now that the level of leveraging in the country’s economy has fallen, and with the improvement in the stock market itself, it should be a good time to invest, says Kawamoto. “But because of the selling from overseas, it remains vulnerable,” she adds.
Alexander Kinmont of Morgan Stanley in Tokyo agrees that the domestic environment is positive, with corporate profits currently surprising analysts on the upside. This upbeat tone to results is likely to continue for at least the next three to six months. “From the domestic point of view there are no good reasons for the market to fall sharply,” he says.
But with technology stocks coming under selling pressure globally, external pressures alone could drive the Japanese equity market lower. “International in-vestors are likely to want to get out of Japan in any environment where hi-tech doesn’t perform,” he says.
The benchmark Nikkei 225 dropped to a 19-month low in mid October, having shown strong, though volatile growth in the first five months of this years.
“It is very difficult for the Fujitsus and Sonys to do well when stocks like Eastman Kodak are crashing over-night,” says Nick Reid, senior investment manager at Gartmore in Tokyo.
But both Kinmont and Kawamoto predict the market will bounce back in the next few months. However, with the maximum rebound probably capped at 5% a month, there is not much room for improvement before the end of the year, says Kawamoto.
Kinmont says the market in a phase where the source of demand for equities is changing. “It is in a slightly uneasy transition from being driven by international demand stocks towards domestic-driven demand,” he says. In sectoral terms, this means buying patterns are edging away from electricals in favour of banks.
This rotation should continue for the time being, Kinmont says. He also sees a 10% bounce in the broad Topix index by the end of the year, with the benchmark adding a further ten percent in 2001. But in the short-run, the market could experience weakness at the start of next year, he adds.
Reid predicts the Topix will rise by about 10 to 15% over the next six months to stand at around 1,600 from 1,440 currently.
In the long-term, technology stocks undoubtedly have more growth potential, but in the short-term foreign selling could drive them still lower, says Kawamoto.
But companies have already given strong indications about the third quarter corporate results they expect to report in November, resulting in many upward revisions. Overall this year, Japanese corporate profits are expected to be up 30% this year, says Kawamoto. She warns, however, that the stronger yen could put pressure on corporate earnings.
Reid also emphasises the strength of the Japanese economy at the moment. Gartmore forecasts GDP growth of 2.5% this year, followed by the same rate next year. “Corporate profits are very much at the vanguard of that,” he says.
He sees corporate profit growth running at around 40% this year, on the back of little, if any, sales growth. Companies have focused on profitability rather than boosting sales, and this means that most of their profit increases has been won on the back of cost cutting.
“So if we do get some sales growth, then there could be some positive surprises,” says Reid. Corporate profits are very positive so far. “Not just in technology, which is expected, but also for cyclicals and in defensive sectors,” he says.
But worries abound, not least because of the consistently high price of oil, which could have implications for global growth, say strategists.

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