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Active Thinking

As Japan’s stock index hit a 33-year high in May, GAM Investments’ Ernst Glanzmann highlights some of the drivers, including a promising earnings season, reforms led by the Tokyo Stock Exchange and the global economic situation.

24 May 2023

Ernst Glanzmann - Japan Leaders

Japan has become quite topical in the press, with publications reporting that Japan’s stock index hit a 33-year high in May. What is driving the market?

One of the main drivers is a better than expected earnings season. Year-on-year net profits, (excluding Softbank, which we view as an idiosyncratic event) are up 13%, while quarter-on-quarter numbers have also been slightly higher. Moreover, a number of companies have been announcing share buybacks, some of more than 10% of the outstanding shares, which is exciting for investors. There is also much interest in the low price/earnings ratio for the Topix Index.

Another key driver is the reforms proposed by the Tokyo Stock Exchange, which focus on improving the price-to-book ratio and cost of capital of primary listed companies. The committee responsible believes that the concept of cost of capital is not well known among corporate managers in Japan and so there needs to be education and improvement, hopefully leading to a better return on equity, profitability, and price-to-book ratios down the road. While the recommendations of the Tokyo Stock Exchange are not hard rules, their advice, combined with the support of Prime Minister Kishida, offers guidance.

In our view, the story going forward is that there will be strong efforts to improve the efficiencies of balance sheets, as well as profitability and operational efficiency in the next few years. This will be a slow process but should be positive for the equity market.

Most of the return on equity improvement we have seen in the last 20 years in Japan is based on the operating profit margin. The asset efficiency ratio has been the main drag on improving the return on equity; once corporates start to work on their net cash positions, there should be a meaningful improvement for companies on their return on equity and this could eventually lead to better price-to-book ratios or a lower cost of capital for shareholders.

We are also positive about the turning points in the rest of the world. Japan still relies heavily on the US economic situation. Looking at the US ISM Purchasing Managers Index, as well as the year-on-year change of US new orders for the manufacturing durables (excluding transport) sector, we believe we are close to a turning point and going forward in the next few months we could expect this to be shown more clearly. The car industry in the US is recouping the issues it had with procuring key electronics parts and is now producing and selling more cars. There is a clear improvement in the demand that is also positive for several companies listed on the Tokyo Stock Exchange.

From a top-down point of view, semiconductor sales are still down year-on-year but we believe we will slowly see improvements. The main drag on the three-month average has been Asia Pacific, which has started to show signs of reaching the bottom; we would expect more positive news going into the summer. We also believe that by then we will have reached a turning point in Japanese robotics.

Regarding operating profit margins of listed companies in Japan, especially in the manufacturing space, we will have to pay attention to the input prices. Looking at the Nikkei 42 commodity prices in Japan, input price pressure should start to ease, and this will have a positive impact on margins going forward. We saw the same with freight rates. This is good news and should be reflected slowly but steadily in the future results as transportation costs are less harmful for operating margins than they were previously.

Since the end of Covid, we have seen tourism bouncing back in Japan. Foreign visits to Japan are getting close to the levels last seen before Covid hit. Total employee income in Japan is growing at close to 3% which should be a supporting factor for private consumption growth.

It seems South Korea and Japan are becoming more closely aligned with the tension between the US and China. Prime Minister Kishida recently invited semiconductor leaders to Tokyo for discussions implying that Japan is willing to accept more semiconductor-related factories to serve the world ex-China with machinery. We expect Japan to position itself as a favourable destination to benefit from the global onshoring trend, which in turn will be positive for Japanese equities overall.

Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Past results are not necessarily indicative of future results. Investors could lose some or all of their investments.
The foregoing views contains forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

Ernst Glanzmann

Investment Director
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