We believe the Japanese equity market will bottom out this quarter in its present range (Nikkei 18,000 and Topix 1,400).
The market should find its feet during the first quarter and will be significantly more buoyant through the summer.
The market has trended downward because market sentiment is overly depressed. Investors feel the economic recovery has lost momentum and underestimate its underlying robustness as well as the speed of regulation. This quarter they should come to realise that things are not so bad.
Sectors that are performing well, such as precision machinery, autos and electronics, should continue to do so. Those which have sold off steeply, such as banks and real estate, should bounce back as investor sentiment recovers.
In the bond market, we believe the government’s policy of keeping interest rates low will continue for most of this year, since it has run out of ways to bolster the economy on the fiscal side and is heavily reliant on monetary side policy tools. We expect bond yields to rise for the rest of the year, so we prefer to focus on equities. Our basic assessment is that the bond market is overbought.
As for the yen, the key point is that it has already weakened to a point where Japanese exports are competitive again. A rise in US bond yields, and the resulting capital losses, should also discourage further capital outflows by Japanese institutional investors - which will temper the yen/dollar exchange rate. So we feel the downside risk from further yen depreciation is limited.
We have found a gap between the perceptions of investors inside Japan and those outside. Those outside see the pace of deregulation and its benefits to the economy as slow, whereas those of us on the ground find it quite brisk. In general, observers outside Japan are now bearish while those here are more constructive.
We think the Japanese market is attractive in terms of a number of factors, such as price-to-book, yield gap and price to cost flow. Our recent analysis concludes that the Japanese equity market is now on the cheap side of fair value.
After more than a decade of experience in investing in Asia, I have found European investors often ask two questions about Japan:
- should we double-up our investment now, and
- what will happen to the yen/Deutschmark rate?
In response to the first, given our feeling that the market will bottom out in the first quarter, this is a better time to buy than sell. As for the second, the downside risk of the yen is now limited, and yen-denominated equities can be bought with less concern about currency movements.
Peter Whelpton is president of NatWest Gartmore Investment Management Japan
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