Arbuthnot Latham’s investment committee has increased allocation to Japan as a way to benefit from the political and monetary shifts resulting from Abe’s Three Arrows.
“Japanese equities are an attractive option for investors as they are gaining momentum, having delivered a strong total return of over +18 percent in 2017, all while valuations remain low relative to history. The Topix 100 traded at an average P/E of ~14x in 2017 vs. last 10 year average of 17x and 18-20x during 05-07 period,” said Gregory Perdon, co-chief investment officer at the private bank.
“The uptrend in Japanese return on equity (RoE), declared dividends and share buy-backs help to support the investment thesis. Interestingly, the value of the Yen has begun to diverge from the stock markets, which may signal a decoupling. However, as the yield differential widens (as the Federal Reserve raises rates and the Bank of Japan remains on hold) this should support the USD, which would on a relative basis appreciate against the Yen. This is the rationale behind our hedged Yen exposure in our equity portfolios.”
By sector, Mr Perdon is optimistic on healthcare IT, automation and auto parts. Controlling the rapid increase in social security expenditures is increasingly important, as the Abe administration works to achieve a primary surplus by fiscal year 2020. Healthcare IT therefore looks attractive, as there is likely to be an increased adoption of electronic medical records and ordering systems to streamline hospital costs. With the implementation of the My Number System in 2016, and greater attention being given to regional medical cooperation, the bank also sees exciting opportunities in security/privacy, big data and cloud computing over the coming years.
Secular tailwinds such as a rapidly ageing demographic and a chronic shortage of labour are creating multiple opportunities for further productivity and efficiency gains through automation. Japan is already a world leader in the production of industrial robots but there are opportunities for further penetration in the nursing care and welfare services sectors – particularly for applications in rehabilitation, monitoring and mobility.
Talking about government bond market, Mr Perdon noted that many market participants have been calling for an end to the Japanese government bond bull market for years (as the interest rate declines – other factors being equal – the bond price appreciates).
“As interest rates rise, investors will change tack and take positions which will see them benefit if the bond price declines. Often referred to as the ‘widow maker trade’, the failure to anticipate this shift has ‘ended’ the careers of many successful money managers over the years.
“Although rising yields would contradict the existing easy monetary policy of the BoJ, it could signal their conviction that inflation is indeed expected in the future – as it’s very difficult to have long-term bond yields at zero while inflation expectations are on the rise.
“We believe that the BoJ will maintain its accommodative policy stance in 2018, but we do see some potential for upward pressure on the long and ultra-long-term part of the yield curve in 2019 as the Japanese economy nudges toward a normalised inflation rate of between one percent to two percent. Only at this stage will we consider participating in the ‘widow maker’ trade.”
Arbuthnot Latham & Co. is a London-based private banking, commercial banking and wealth management arm of the Arbuthnot Banking Group, with regional offices in Manchester, Bristol and Exeter and an international branch in Dubai.