The Japanese market rose in each month of the quarter to record a total return of 8.6%, but underperformed other major markets, especially in December. Across the quarter as a whole the yen weakened slightly against the US dollar but generally remained in a range which is comfortable for both the US and Japan. The cross-rate with sterling was much more volatile, driven primarily by the UK’s domestic political timetable. For the quarter as a whole there was a significant net weakening of the yen which restricted the total return for a sterling investor to just 0.5%.
Sentiment towards Japanese equites fluctuated in line with geopolitical tensions but was ultimately helped by signs of some easing in relations between the US and China and expectations for the signing of a Phase 1 trade agreement. Foreigners generally remained net buyers of Japanese equities for most of the quarter, which also influenced stock leadership and sector performance. In reaction to the market strength, the Bank of Japan has stepped back from ETF purchases over the last three months and has therefore undershot its own target for the calendar year. Although this has led to some suggestions that the Bank of Japan is already tapering its monetary policy, we do not currently expect any reduction in the ETF purchase target for 2020.
Japan’s economic data continued to show a significant divergence between the strength in service sectors and the weakness in manufacturing. There were also signs that the long-running trend towards an ever-tighter labour market had finally reaching its natural limit. Japan has effectively been operating at full employment for some time and it was statistically inevitable that the unemployment rate must bottom out eventually. However, this does not necessarily imply that the wage growth cycle is also peaking, as structural conditions remain in place for wages to move higher.
The main economic event for the quarter was the consumption tax increase on 1 October. Some evidence of front-loading demand ahead of the tax increase was visible, but it is now clear that the subsequent downturn has been somewhat greater than consensus expectations, even if allowance is made for the devastating typhoon which hit central Japan in the same month. In response, the government has announced a significant supplementary budget, with a particular focus on reconstruction, which should help to support economic growth after this short term weakness. Investors have generally responded positively to this planned fiscal stimulus, while the Bank of Japan governor, Mr Kuroda, has welcomed the change in emphasis away from monetary policy alone.
The Bank of Japan itself made no change in policy this quarter, although there had been a possibility that rates would be cut further into negative territory in late October following the latest rate reduction by the US Federal Reserve. In the event, views remained balanced between the need to continue aggressive easing and fears over the detrimental impact of negative rates on the financial system. The Bank of Japan was also able to take advantage of the recent period of modest yen weakness against the US dollar to postpone any further moves until at least the next meeting.
The most recent quarterly reporting season for Japanese companies ended in November and was generally in line with expectations. The overall impression from the numbers was that we may be close to the end of the recent cyclical slowdown in earnings. The revision index for corporate profits remains in negative territory, but could reverse as we approach the end of the fiscal year in March 2020.
At the individual stock level there have recently been several examples of corporate activity which we see as a direct consequence of Japan’s drive towards better corporate governance. During December, for example, an impending restructuring among Toshiba’s group companies became particularly interesting as the parent company has found itself in a competitive tender to acquire Nuflare Technology. The emergence of an alternative bid for Nuflare from Hoya, despite a previously close relationship between Hoya and Toshiba, has again focused attention on the rights of minority shareholders and the ways in which value can be realised from within Japanese companies.
Unfortunately, Japan’s path to better governance appeared to be interrupted in October by the announcement of tighter restrictions on foreign investment into a very broadly defined range of “security-related” industries. Although the new regulations are aimed at protecting these industries from undue foreign influence, we recognised the potential for significant collateral damage to foreign asset managers and, by extension, to the equity market. The situation continues to evolve through dialogue with the authorities and a series of clarifications, which now suggest to us that this change will ultimately have much less impact on the market than we initially feared. Nevertheless, there will be some negative implications for foreign activist investors who will face an additional administrative burden. We continue to engage with the authorities on this issue, but we need to wait to see the actual regulatory framework and a definitive list of companies ahead of the final implementation, which is likely to be in April 2020.
|Q1/2015 - Q4/2015||Q1/2016 - Q4/2016||Q1/2017 - Q4/2017||Q1/2018 - Q4/2018||Q1/2019 - Q4/2019|
|Net Asset Value||19.5||23.0||16.1||-12.7||13.6|
|TOPIX TR JPY (GBP)||18.2||23.4||15.6||-8.4||14.6|
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
The Company invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment companies that invest in larger companies.
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