Will Japan prove to be the contrarian’s market in 2013?

2nd January 2013 by Darius McDermott

Japanese equities are my contrarian bet for 2013. We’ve had many a false dawn with the asset class. Much is written about the country’s low-growth economy and unfavourable longer-term demographics, and it is extremely cyclical as a market, which can make investing tricky.

But I’ve been invested in Japanese equities for a few years now and, while it can hurt at times, I’ve had more good years than bad. While it was the only major market not to make any money in 2012* – I think 2013 could be one of those good years.

Why? For starters, it is home to many world-leading companies, particularly in the technology and auto-making industries. And there are a wide variety of companies to choose from – more than 3,500 listed companies in fact. With large parts of the market now overlooked as fewer analysts are covering them these days, if you can find a manager with a well resourced team behind them, they should have an advantage.

While economic growth has been low for some time, the domestic economy is pretty resilient and has undergone a lot of restructuring. Unlike the western world, the banking system is now healthy after 20 years of restructuring and the corporate sector is becoming bolder, having cut costs aggressively in the main part and improved cash flow quite dramatically. Balance sheets are generally in good order.

Over the last two years, Japanese companies have represented more than 10 per cent of all cross-border M&A – second only to the Americans. Indeed, overseas acquisitions are set to hit record levels for 2012 and this trend should continue into 2013 as corporates look to expand overseas.

The policies announced in recent weeks (in the run up to the elections on 16th December) have been very market-friendly including, importantly, a 2%+ inflation target, cutting the corporate rate of tax, unlimited easing in monetary policy and more robust foreign policies.

Key catalysts to unlocking the value inherent in the Japanese market are inflation and a weaker Yen so this first policy is extremely encouraging. And the Yen has also weakened recently. If this can be maintained, foreign investors should start to address their underweight positions in the asset class which would be a big boost to the market.

In addition, the market is looking attractive on valuations – both in terms of its own history and compared with other equity markets – and almost two-thirds of listed companies are trading below book value.

The market has also been less volatile than its peers in the last 5 years or so with the exception of the weeks immediately following the dreadful earthquake and tsunami. Having had a banking crisis of its own and come out the other side, it has not felt the impact of the global financial crisis to the same extent as other countries, which bodes well, should more hiccups occur in the Eurozone in 2013.

On a more positive note, Japanese equities are also prone to sharp rallies as the market is leveraged to the global economy so, if the state of the world improves – which I think it will – we could see a geared recovery play in the asset class.

*Source: FE Analytics, Total returns 1st January to 6th December 2012. Topix compared with S&P 500, FTSE 100, DJ Euro Stoxx 50 Cap, MSCI Asia ex Japan and MSCI Emerging Markets.

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