Don’t overlook Japan

Fidelity Japan Trust PLC’s Nicholas Price reviews the current fundamental and valuation backdrop on-the-ground in Japan. After a challenging 2018 for Japanese equities, he discusses why he is feeling increasingly positive and reveals some of key areas of opportunity among domestically-focused stocks and sectors.

Key points
 

  • Sentiment towards Japanese equities over the last 12 months or so has been impacted by slowing global trade and US-China trade tensions.
  • Given the significant valuation adjustment that we have seen, the risk/reward trade-off now looks very attractive.
  • We see several opportunities among mid and small-cap firms that are more domestically-focused and are therefore less impacted by a slowdown in external demand.

Despite risks from slowing global trade and the threat from US-China tensions, investors should not overlook the opportunities in Japan. Indeed, while the outlook for equity returns has been tempered by cooling earnings growths, the significant compression that we saw in Japanese price-to-earnings ratios over the course of last year suggests that this has now largely been discounted.

Looking ahead, we see a favourable risk/reward trade-off for investors in Japan over the mid to long-term with valuations testing historical lows in some parts of the market. The policy backdrop from the Bank of Japan remains benign and as we progress through the year we expect the authorities to deploy counter measures to mitigate the effects of the upcoming consumption tax hike in October. There is also encouraging signs of progress being made on structural reforms.

Domestic opportunities in Japan

Amid a slowdown in external demand, economic activity in Japan is likely to be sustained by domestic demand. In this environment Fidelity Japan Trust PLC is focused on growth-oriented mid and small-cap companies, with around 70% of the portfolio’s underlying revenue streams coming from domestic Japan.

The medium and smaller companies space continues to provide a wealth of under-researched investment opportunities in Japan with superior alpha-generating potential. In line with this approach, areas where I see investment potential in the coming year include:

  • Stable growth companies that can increase earnings as the global economy shifts from acceleration to stabilisation.
  • High quality services and machinery companies geared to structural growth trends, such as recruitment, MedTech and automation.
  • Under-researched companies with new and interesting business models, as well as selected unlisted opportunities which I can capitalise on given the trust’s closed-end structure.

At the individual stock level, we currently see a number of opportunities to capitalise on unwarranted valuation discounts in these areas with the likes of Recruit (staffing/recruitment), Makita (power tools) and Keyence (factory-automation sensors) all high conviction holdings.

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Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity Japan Trust PLC can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in smaller companies can carry a higher risk because their share prices may be more volatile than those of larger companies. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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