Investors should target companies with independent growth drivers to avoid the pitfalls and capture the upside in 2020 and beyond. Despite a resurgence in the second half of 2019, Japan’s equity market has comfortably underperformed global peers over the past two years.
Although there are tentative signs of stabilization in global growth, and the US and China have reached a trade agreement in principle, remaining tariffs and economic and political obstacles to a more comprehensive deal dent our confidence about a potential rebound.
Persistent trade tensions not only between China and the US but also Japan and South Korea have implications for global supply chains and corporate spending. Domestically, the negative impact of October’s VAT hike has been a major focus, crimping spending among households.
With the Bank of Japan on the sidelines for now – having kept rates on hold in October even amid growth concerns – the government has announced a ¥13.2 trillion ($121 billion) spending package.
However, only a third of these funds have been allocated to the supplementary budget, with the rest to be distributed over several years – reducing the bang for buck. Bear in mind, the government has to balance economic revitalization with managing the nation’s debt sustainability.
The fate of the industrial cycle remains a critical consideration
Although inventories look leaner, downbeat sentiment in the manufacturing sector points to an L-shaped recovery, rather than V-shaped.
In the event that momentum in the industrial cycle rebounds, Japanese equities remain a good tactical play. The practice of returning cash to shareholders is catching on fast. However, if the US tips towards an end-of-cycle event amid trade disputes, the Bank of Japan may struggle to contain yen appreciation. That would adversely impact equity market performance.
Given such uncertainties, investors should focus on companies with independent growth prospects. We see two areas to target: self-reliant firms that don’t depend on external stimulus; and diversified companies that benefit from non-discretionary offshore earnings.
Firms with strong balance sheets and leading market shares are best able to drive their own growth and sustain dividend payments. They can also capitalize on record low-interest rates to push through growth-enhancing mergers and acquisitions.
After several false dawns, we are seeing strong momentum behind corporate governance improvements. They can make Japan a materially better market for investment and go some way towards unlocking the tremendous value on overcapitalized balance sheets.
Understanding environmental, social and governance (ESG) factors enable investors to assess the sustainability of a company’s business model and its ability to prosper. Such detailed due diligence will be key to identifying Japan’s winners and losers in 2020 and beyond.