The sun is rising on Japan’s economy

However, the increases in stock prices depend on further signs that the policies of Japan’s new president, Shinzo Abe, aimed at returning the country to healthy economic growth are effective. This is tricky because Abe confirmed on Oct. 1 that the sales tax will rise to 8% from 5% on April 1, 2014, then to 10% in October 2015 to reassure international investors worried about Japan’s massive debt of more than 200% of gross domestic product.

To offset the obvious negative impact this rise could have on consumer spending, Abe has announced a stimulus package of about US$50 billion, which includes lower investment taxes, as well as more funding for venture-capital funds and promoting younger people and women in the workplace. Abe also is urging companies to increase wages with the higher profits they are getting as a result of the drop of about 20% in the value of the yen that has come from easing of monetary policy.

Abe would have liked to have cut corporate taxes, which would enable companies to raise wages and also encourage firms to increase their capital spending, but he is still trying to garner enough support within his political party to do this. He says a decision on this will be made before yearend.

For your clients, the key metric to keep an eye on is the value of the yen, says Mark Grammer, senior vice president of investment management with Mackenzie Financial Corp. in Toronto. If the markets have doubts about whether Abe’s measures will work, they will bid up the yen, which will have a negative effect on Japan’s exporters’ profits and, thus, on Japanese stocks in general.

Currently, the yen is down by about 20% from a year ago, and this has resulted in strong profits for exporters, given the cost-cutting forced on corporate Japan during the years of the yen’s high price, during which much production labour was moved to lower-cost countries.

“Japanese companies,” says Dibb, “now are much more competitive vs companies in other countries.”

Economic growth for the second quarter initially disappointed, at an annualized 2.6%, but was revised to 3.6%. Also, Japan’s monthly consumer price index was up year-over-year in August for the third month in a row.

Some inflation is key to Japan returning to healthy economic growth. The country has been experiencing deflation for the past 20 years, and that means consumers have kept putting off purchases of durable goods, including housing, furniture and appliances, in the belief that these will be cheaper in the future. As with most industrialized countries, consumer spending is the major engine of growth.

What Abe is trying to do is reflate Japan’s economy so that wages and asset prices start to increase. He has a strong hand, given his landslide victory in the December 2012 election for the lower (main) elected body, followed by another big majority in the upper house’s election in July.

Down the road, Abe wants to implement further reforms aimed at improving flexibility in the labour market and opening Japan’s economy to more competition. As in Europe, it’s very hard to dismiss employees in Japan, and much of the country’s economy is protected against imports.

Abe also is supportive of Japan’s involvement in the Trans-Pacific Partnership trade talks, which could see major reductions in Japan’s import tariffs. Other countries involved in these talks include the U.S., Canada, Mexico, Australia, New Zealand, Peru, Chile, Vietnam, Singapore and Brunei.

Here’s a look at some of the Japanese stocks that fund portfolio managers believe represent good investment opportunities:

– east japan railway co. (ejr) is a play not only on increased volumes as consumer spending picks up but also on real estate appreciation.

Japan’s railways are very efficient and fast, and the trains are new, says Charles Burbeck, co-head of global equity portfolios with UBS Global Asset Management (U.K.) Ltd. in London. Thus, the railways are well used and well run. Like most companies in Japan, EJR is overstaffed, but many employees are nearing retirement and either won’t be replaced or new hires will start at lower wages. With increased volumes, EJR should also be able to increase transport prices, which the company hasn’t done for seven to eight years.

EJR also owns a significant amount of real estate around its stations, which the firm has been developing successfully, says Burbeck. There still is lots of potential, though, he adds, pointing in particular to the possible development of millions of square feet around EJR’s big central Tokyo station into office space during the next five years.

EJR’s stock is attractively valued, Burbeck says, as it recently closed at ¥8,440 ($86.91) a share on Sept. 30, and is a “very good way to play the fall in real yields and the pickup in the domestic economy.”

– mitsubishi estate co. ltd. This firm owns “significant amounts” of high-end real estate in downtown Tokyo, so the company will be a major beneficiary of rising real estate prices. Mitsubishi Estate also should be able to increase rents if economic growth picks up. As a result, analysts with J.P. Morgan Securities LLC in Tokyo have an “overweight” rating on the stock, with a December 2014 price target of ¥3,000 ($30.89) a share. The stock closed at ¥2,896 ($29.82) on Sept. 30.

– shiseido co. ltd. Cosmetics is a high-margin business, and Shiseido is a global player that competes with high-end brands such as L’Oréal and Estée Lauder. Shiseido is one of Burbeck’s picks as a play on the expected pickup in Japanese consumer spending because the domestic market accounts for about 50% of Shiseido’s total sales; this also is the market in which the company has the largest market share and, thus, pricing power. Burbeck notes that retail shelf space for cosmetics has declined in recent years, but he expects this trend to reverse.

In addition to Shiseido’s strength in its home market, the firm also has a large presence in the U.S., as well as a good emerging markets business that, Burbeck says, has held up despite concerns about slower growth in those countries.

Burbeck likes the appointment of Shinzo Maeda, the chairman of Shiseido’s board of directors who has been with the company for more than 40 years, as Shiseido’s president and CEO as of April 1. Furthermore, Burbeck says, the stock’s valuation is cheaper than those of its global competitors.

A report from J.P. Morgan gives an “overweight” rating on the stock, with a December 2014 price target of ¥1,740 ($17.92) a share. The stock closed at ¥1,692 ($17.42) on Sept. 30.

– shin-etsu chemical co. ltd. is a play on the recovery of the U.S. housing market because the company is one of the biggest suppliers of polyvinyl chloride piping in the U.S., Grammer explains. This firm also has a large global share of semiconductor silicon, for which demand is picking up.

– sumito mitsubishi trust bank ltd. Grammer, who favours this stock, explains that financials, in general, are expected to benefit from the reflating of Japan’s economy, which should lead to an increase in the net interest margin as consumers and businesses borrow more. The stock market also is expected to rise further, which will be good for wealth-management operations.

– tokyo tatemono co. ltd. is another real estate firm that owns lots of property in downtown Tokyo. This stock is one of Grammer’s picks, but the J.P. Morgan analysts rate it as only “neutral,” with a target of ¥920 ($9.78) a share. The stock closed at ¥1,125 ($11.96) on Sept. 30.

– toyota motor corp. is favoured by many analysts. This company went through major cost-cutting and restructuring to enable it to compete globally when the yen was high, at around ¥80 (85¢) per US$1; Toyota now is raking in the profits at ¥100 ($1.06) per US$1.

Historically, Toyota was profitable only when the exchange rate was ¥130 ($1.38) or higher per US$1. Toyota also has a significant share of about 40% in the Japanese market and is well positioned to benefit if Abe’s policies work and higher profits get recycled into higher wages and bonuses.

Dibb and Grammer both like the stock. A J.P. Morgan report gives it an “overweight” rating in anticipation of it trading at a 30% premium to the auto sector, based on Toyota’s conservative accounting and sound finances. That translates into a price target of ¥9,000 ($95.67) a share by December 2014. The stock closed at ¥6,270 ($66.65) on Sept. 30.IE

 

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