Can Japan continue to deliver?

Nicholas Price, portfolio manager of Fidelity Japan Trust PLC, share his outlook for 2024. He assesses whether Japan’s recent market leadership can continue and outlines how he believes shifting macro dynamics, coupled with corporate governance improvements, are creating new areas of opportunities for investors.

What is your investment outlook for 2024 given the prevailing macro environment?

Japan’s delayed reopening and the return of inbound tourists are supporting growth in consumption and services demand. At the same time, the economy is transitioning to a moderately inflationary state, as companies are finding it easier to raise prices and are increasing wages.

We also see growing pressure on companies to enhance their corporate value and utilise excess cash to fund investments and shareholder returns. This is driving progress in the rationalisation of corporate structures and further reductions in cross shareholdings.

In my view, the biggest near-term economic risks are still around inflation and how interest rates can impact market valuations and levels. Continued sighs of weakness in China’s recovery and the risk of US recession also represent potential headwinds that could prompt a near-term adjustment in Japanese stocks. However, the accumulation of above-mentioned positive factors is supportive of the mid-to-long-term outlook for the Japanese market.

What do you think could surprise markets in 2024?

Expectations around China have really taken a hit and the emergence of a moderate recovery could surprise on the upside. An attendant pick-up in the capex cycle would be positive for factory automation-related companies that are optically expensive at the bottom of the cycle but offer good value on a trough-to-peak view.

In terms of potential negative surprises, the market expects the Bank of Japan to implement some form of policy normalisation in the coming year. If the central bank under Governor Ueda fails to deliver, that could be a shock. Japanese financials that have performed quite strongly in 2023 would be most at risk in this scenario.

What has worked well in your portfolio over 2023?

The Japanese equity market has reached multi-decade highs in 2023 and performed well relative to other developed markets. Under the surface, however, a sharp style divergence has been evident, with value stocks significantly outperforming their growth counterparts. Style factors, combined with a slow recovery in the factory automation sector, have created performance headwinds for the portfolio. Conversely, key active positions in technology-related cyclicals have outperformed ahead of an expected bottoming of the semiconductor cycle. Holdings in differentiated small-caps have also added value.

I am focused on growth at reasonable value and holding companies that are trading at or close to market multiples, despite offering consistent mid-term growth. Contrarian growth names - stocks that are really disliked by the market but where we see catalysts for change - are another area that I am focusing on. At the same time, shifting macro and market dynamics also create opportunities. For example, rising interest rates in Japan mean that I own Japanese banks for the first time in many years.

Where are the key areas of opportunity in 2024?

Japan’s technology and materials sectors hold a lot of promise. Globally competitive companies in semiconductor equipment and electronic components are trading on compelling valuations as we approach the trough of the cycle. There are also niche chemicals companies that command dominant positions in their global markets yet continue to fly under the radar. Another area of the market that I would highlight is the mid and small-cap growth space, an often-overlooked segment that is trading on cheap valuations.