Outlook 2017: Japanese equities
- The US election result brings uncertainty over Japan’s outlook.
- Currency expectations will continue to be an important influence on investor sentiment and on the performance of the Japanese market.
- Relatively low valuations and improving corporate governance should provide support.
If the higher US interest rates and stronger dollar that have prevailed since the election are sustained, the Japanese equity market would be well supported by improved earnings expectations and extremely low long-term domestic bond yields. However, the lead up to president-elect Trump’s inauguration in January and his initial period in office could easily see a series of unpredictable events.
US uncertainty clouds the picture
Globally, investors have so far adopted a positive interpretation of an increase in US growth stimulus, but sentiment surrounding this in Japan could still prove fragile if protectionist tendencies surface in 2017 and begin to dampen longer-term growth expectations.
One early outcome appears to be the definite withdrawal of the US from the Trans-Pacific Partnership trade agreement. Although implementation of this would have been a net positive for Japan, few areas of the market had really moved in anticipation of any agreement, and confirmation of the US withdrawal does not represent a major negative for equities at this stage.
The outlook for Japan, and in particular the sentiment of equity investors, also remains somewhat dependent on expectations for the currency. In the immediate aftermath of the US election, currencies have moved to reflect widening interest rate differentials, resulting in a weaker yen and therefore improved sentiment in the Japanese market. However, the risk remains that Japan’s perceived status as a safe haven currency could result in renewed yen strength if unexpected developments from here lead global investors to a more risk-averse stance.
Brighter domestic backdrop
Behind these external risks, the domestic environment remains rather more encouraging. With coordinated fiscal and monetary policy providing strong support for equities we would expect the current period of political stability under Prime Minister Abe’s leadership to also provide an opportunity for longer-term structural reforms of taxation and the labour market.
Although we do not currently expect any significant new policy developments from the Bank of Japan (BoJ), its ongoing stance remains aggressively loose going into 2017. At present we see no real pressure on the central bank resulting from the spike up in global bond yields, even though the BoJ has committed to maintaining 10-year yields around zero.
While the impact of Japan’s reflationary policies (designed to expand economic output and curb the effects of deflation) over the last three years has been somewhat patchy and slower than originally hoped, economic data in the second half of 2016 has been mildly positive.
Looking into 2017, the current trends in currencies and oil prices, in particular, could now provide a tailwind for the BoJ’s efforts to pull the economy out of deflation. At the same time, we see the outlook for corporate profits picking up and expect to see a positive cycle for profit revisions, especially among domestically-focused mid and small cap companies, while larger exporting companies could also see a strong benefit from the current weakness of the yen.
Valuation and governance support
A relatively low starting point for valuations gives us further confidence that earnings growth over the next couple of years can also be reflected in a re-rating of the market.
In addition, we expect 2017 to see further improvements in corporate governance in Japan, continuing the progress seen in the last three years since the introduction by the Abe administration of the Corporate Governance Code and the Stewardship Code. Linked to this is our expectation for further increases in overall shareholder returns in the form of higher dividends and share buybacks.
Over the coming year, it is possible that Japan will need to begin to address broader regional issues if the US moves to a more isolationist stance. This could have direct implications on Japan’s level of defence spending and also affect the country’s willingness and ability to take a more active role in overseas disputes.
Although a more aggressive and interventionist stance is unlikely to receive broad public support, Mr Abe himself is likely to be comfortable in portraying a more active role for Japan on the international stage. This is also likely to be reflected in a realignment of diplomatic relations between Japan and its Asian neighbours if the US adopts a more inward-looking stance. As we move into 2017, however, these longer-term issues are unlikely to be the immediate focus of attention. Equity investors will instead be looking to identify which elements of Mr Trump’s pre-election stance survive into the real-world of American politics.
Japan remains a major player in world trade and cannot fully escape periods of global uncertainty, especially if this is transmitted through a stronger currency. However, with ongoing policy support, Japan’s domestic economy could well be moving into a more robust period and we would expect corporate Japan to benefit accordingly.
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