Despite generally weak sentiment during the past three months, the Japanese equity market showed a positive total return of 1.1% for the quarter. Although further uncertainty was created by rising trade tensions, the Japanese yen lost ground against a generally stronger dollar. Against sterling, however, the picture was reversed and yen gains pushed up the total return for a sterling-based investor to 3.8%.
The results season for the fiscal year which ended in March was completed in early May, with profit numbers broadly in line with expectations after a period of successive upward revisions in the second half of 2017. Companies’ own expectations for the year to March 2019 appear to be rather conservative, partly as a result of the stronger yen rates prevailing at the time the forecasts were made, which potentially leaves room for upward revisions later in the year.
Much of the quarter was very quiet in terms of Japan-specific news, with investors focused instead on escalations in trade tension between the US and China, and increased strains within the European Union. The most important aspect for Japan has been the increased potential for the US to apply tariffs to auto imports. Although Japanese makers already have consistently moved production facilities offshore, auto exports still represent a significant part of Japan’s trade balance. The complexity of auto supply chains creates further uncertainty for Japanese automakers who are already re-evaluating their global strategy in light of the new-found propensity of the US to tear-up pre-existing trade agreements.
Away from politics, forward looking economic indicators had been pointing towards a recovery from the short-term GDP decline seen in the first quarter. Data on the real economy released at the end of June subsequently provided some positive surprises with industrial production and inflation data for Tokyo both ahead of expectations. Although investors have apparently become rather accustomed to the strength of the labour market, a decline in the unemployment rate to 2.2% is still significant and should be viewed as positive for inflationary expectations.
Aside from any potential impacts on the auto industry, Japan should not be disproportionately affected by the issues currently weighing on global equity markets. In fact, the different timing of policy cycles should actually work in Japan’s favour as it continues to pursue an aggressively loose monetary policy while both the US and Europe look to tighten. Although there is now strong evidence that Japan is recovering from the soft patch seen in the domestic economy in early 2018, there is, as yet, no incentive for the Bank of Japan to signal any change in monetary policy. We now await important decisions from the government on fiscal policy, especially in relation to the rise in consumption tax scheduled for October 2019 and any offsetting stimulus which the government will apply to smooth the transition to the higher tax rate.
Although Prime Minister Abe continues to be hampered by the hangover from recent scandals, there have actually been no fresh revelations in the last few weeks. If this situation persists through summer, the simple passage of time increases the likelihood that Mr Abe will be re-elected as party leader for a further term in September. In any event, with Japan seemingly remaining on its path towards a sustainable exit from deflation, there is likely to be a high level of policy continuity even if we were to see a change in leadership.
Japan, along with all global equity markets clearly faces a number of potential external risks at present. However, under the current business conditions and currency levels, we remain confident that the reflation of the domestic economy will feed through into corporate profit growth, which will justify current valuations.
The Fund underperformed the benchmark in the quarter, with the largest negative contribution from individual positions came from Disco, a maker of specialist equipment for semiconductor production. The stock has seen some profit taking in the quarter after sustained outperformance over the previous two years.
The largest positive impact came from TDK, an electronic component supplier which continued the solid outperformance seen over the last twelve months on expectations for higher profits driven by use of the company’s technology in new growth areas such as automobiles and rechargeable batteries.
There was a range of portfolio impacts from higher oil prices in June, which led to a negative contribution from the overweight position in Japan Air Lines but a slightly larger positive contribution from the overweight position in JXTG, a major oil refiner and distributor.
|Q2/2017 - Q2/2018||Q2/2016 - Q2/2017||Q2/2015 - Q2/2016||Q2/2014 - Q2/2015||Q2/2013 - Q2/2014|
|Net Asset Value||10.2||32.5||-6.8||33.1||1.5|
|Tokyo Stock Exchange 1st Section Index (TOPIX) (TR)||7.4||33.0||9.5||18.4||-1.2|
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