Jupiter JGF Japan Select manager Simon Somerville says Japan’s market gains sparked by the weakening yen are almost over but gains for Japanese equities will be sustained over the longer term by the belief that inflation is on the way.
The Topix is up more than 30% since late December, with the market encouraged by Prime Minister Shinzo Abe’s attempts to drive the yen down to help the country’s exporters, as well as running a dovish monetary policy to target mild inflation for the country.
While the yen versus dollar movement has reached 94 - Somerville expects it to get to around 100 yen to the dollar - it is the move to create modest inflation that will help sustain a more buoyant stock market after years of deflation as investors start to move back into equities.
Euro Stars AA-rated Somerville expects Japan’s huge army of domestic institutional investors to start to switch their long held overweight in bonds into equities over the next two to three years. They are currently running at record low allocations to equities of around 7-8%
He believes April’s Bank of Japan (BoJ) meeting could be the potential catalyst for that change in investor sentiment as he expects a further round of fiscal stimulus to be announced.
Somerville told Citywire Global: ‘The yen trade could get to 100 against the dollar but it won’t go much further because of cost inflation especially on oil imports. The majority of that trade has been done but the next driver will be the belief that inflation is coming.'
Mild inflation 'hugely profitable'
‘Japan has had deflation for so long that a sustained period of mild inflation would be hugely profitable. Domestic institutional investors are still stuffed full of bonds but the move towards an inflationary world would make them less attractive than equities.’
He stresses that the lack of movement by the Japanese government bond (JGB) market since the start of the market’s move upwards only serves to make Japanese equities look even cheaper.
‘Yields on 10 year JGB’s were at 75 basis points at the start of November when the Nikkei was at 9000 and the yen was trading at 79 to the dollar. If you had told me the yen would get to 94 and the Nikkei index to 11,500 I would have expected to see some movement but bond yields have been static.'
‘If JGB’s fell very sharply to 1.5% the relative returns from them would stop people moving into equities but that is not happening.’
Somerville suspects the switch by domestic investors from bonds into equities to take place over a long period of time as institutional investors are typically very slow to react to asset allocation changes.
In terms of the yen, Somerville sees the G20’s decision not to intervene in the BoJ’s attempts to weaken its currency as a further positive, although he thinks attempts to drive it north of 100 will ultimately be counterproductive and unhelpful to the domestic economy.
‘The G20 sees it as a policy move, not an interventionist one, but when the yen gets to its target range of about 100 it will be much harder for Abe to talk the currency down further.’
Citing the effects of rising oil import costs he added: ‘Since the end of July, the oil price in dollar terms is up 15% but in yen terms it is up 36%.’
Over the past three months Somerville has been reducing his defensives exposure and increasing his weighting to car makers Nissan and Toyota as he sees the sector as the purest play on the depreciating currency.
He is now overweight the two firms as well as Toyota’s subsidiary component makers, while his other key play is an overweight to the big Japanese domestic banks which he expects to be the main beneficiaries of an inflationary environment further down the line.
The fund has around 15% in the big banks compared to the index’s 11%.
Over five years the fund has returned 24.4% compared to 13.3% by the Topix index.