Japan Continues To Be The Relative Value Trade In Equities

This is not a recent development. The country has looked relatively cheap over both short and long-term investment horizons and continues to pivot its economy for a period of sustained growth. 

It is therefore surprising, though beneficial, to see it so under-owned, with the latest Fund Manager Survey from Bank of America Merrill Lynch showing a 4% underweight to Japan. 

Abenomics is proving itself to be a positive influence on the prospects for Japanese businesses.

Corporate governance reforms are making a real difference to the way businesses are run and this is having a positive impact, with net profit margins improving as a consequence.

The innovative companies diffusing Japan's demographic time bomb

We have seen higher numbers of non-executive directors introduced onto boards, as well as improved female participation in the workforce. 

These changes may be slow but they are having a beneficial effect on the wider economy. 

Nonetheless, it can be difficult to discern the impact of these changes, which take time to manifest, and some of the economic data coming out of the country has been poor, which may be preventing Japan from becoming a more crowded trade.

Its manufacturing PMI remains below 50 following a slump at the turn of the year, while inflation is still below the target level of 2%.

Sales growth has been one of the positive results to come out of corporate Japan during the recent earnings season, but this has also been tempered by the negative earnings revisions that have accompanied it.

Furthermore, the monetary policy decisions made since 2012 mean the Japanese government now owns more than 4% of the equity of constituents of the Topix index.

The introduction of this significant but price insensitive buyer may be having a distorting effect and creating a false market for Japanese stocks - although the true effects may be unknown for some time.

Sacha Chorley is a portfolio manager at Quilter Investors

Bull Points

• Only major region with a discounted valuation

• Businesses are improving as a consequence of Abenomics and corporate governance reforms

Bear Points

• Economic data has been weak, in part due to sensitivity to the global trade slowdown

• Earnings per share levels have been declining whereas most of the world has continued to see growth