By Ivailo Dikov, Head of Japan Equities, and Oliver Lee, Client Portfolio Manager at Eastspring Investments.
Foreign investors have been buying Japanese stocks and pushing the market to 33-year highs. Year to date, the MSCI Japan index has returned 11.6% in USD terms. Investors, late to the game, are wondering if much of the rally is over. After the strong market run, Japan’s equity valuations are now at the 10-year historical average of 14x earnings and as such no longer optically cheap versus its own history.
However, the cyclically adjusted (CAPE) multiple for the market is still below its average and at 1.5x price to book, Japan remains cheaper than both Europe at 1.9x and the US at 4.3x. Fig 1. We prefer to characterise Japanese valuations now as being attractive rather than super cheap. The long-term investment case remains very solid, supporting the case for more market upside.
Fig 1: Japan is attractively valued
Source: Eastspring Investments, IBES MSCI Indices, Refinitiv Datastream, as at 30 June 2023.
Tailwinds powering growth
That said, the current investment buzz on Japan is being powered by several other factors. For a start, it is worth noting that Japan, an open economy, has benefitted from the benign global backdrop; expectations of an imminent recession have not panned out thus far. The global economy remains relatively resilient.
Meanwhile Japan’s economy grew at a faster than expected pace in the 1Q23 and current account surplus more than doubled year-on-year in May on a smaller trade deficit and higher investment income. To add, Japan’s post COVID re-opening only started from this year, accelerating towards the second quarter, and boosting the domestic economy. There is plenty of room for more growth.
Rising inbound tourism will be another major growth driver; per capita spending by tourists hit a new high in the 1Q23. Imagine the boost to spending should Chinese tourists return in full force; currently it is negligible. Pre pandemic they used to be the biggest spenders and account for 30% of arrivals.
An attractive proposition awaits
The valuation divergence between growth and value stocks is still elevated versus history. We are seeing plenty of opportunities in the value and mid cap space and will assess companies based on the through business cycles and sustainable earnings.
Japan is also well positioned to handle any fallout from any rising US-China tensions. Both China and the US are Japan’s key trading partners, with the latter supplying both countries with much needed technologies i.e., electrical components, materials, machinery etc.
Overall, the long-term investment case remains solid, and we would characterise the current Japanese valuations as attractive rather than super cheap. Many foreign investors are still looking to build more permanent Japan equity positions in their portfolios. The ongoing share buybacks are also pushing up yield to 2.5%+ which should encourage retail investors back into the equity market.
Japanese equities are set to remain in demand in the second half of the year. Any pullback in the market is likely to be used as a buying opportunity by investors. Perhaps the time has come for Japan to trade at a premium to long-term depressed valuation levels.
