In the following commentary, the Portfolio Management teams of the Hennessy Japan Fund (Trades, Portfolio) and Hennessy Japan Small Cap Fund (Trades, Portfolio) explain the investment case for Japan, discussing the government’s plans to stimulate economic growth and the current drivers of corporate profits growth.
- How does the government plan to stimulate growth under Abenomics 2.0?
Under Abenomics 2.0, Prime Minister Shinzo Abe announced measures in three main areas: demographics, welfare spending and industrial policy designed to help fuel long-term growth. In the first two areas, the impact of government initiatives, which include incentives to help increase the birth rate and improve senior services, will take time to materialize. We are optimistic however, that the industrial policy initiatives will have a measurable impact over the next few years and will drive faster economic growth, allowing the government to meet its target of 600 trillion yen in nominal GDP by the year 2020. Under the industrial policy banner, several strategic public and private initiatives are already underway, including:
»» Creating new markets focused on health care and housing reforms along with energy-related investments.
»» Spending on infrastructure in Tokyo for the 2020 Summer Olympic games.
»» Promoting tourism to increase spending by foreign visitors.
With regard to Japan’s tourism industry, from January through November 2016, 22 million tourists visited the country, up 20% over the previous year and higher than the government’s 2016 target of 20 million. The government is looking at a target of 40 million visitors by 2020, which would represent a growth rate in the number of tourists of approximately 20% annually, in-line with historical growth rates. We believe tourism in Japan has plenty of room to grow, as the total number of visitors is still small compared to many other countries, and the tourism industry in Japan, at just 0.6% of GDP, is relatively small.
2. What other reforms might have a significant effect on Japan’s economic growth rate?
The government is addressing the need for labor market reform and is trying to narrow the gap in wages between full-time and part-time workers and increase the number of full-time employees through an “equal pay for equal work” guideline. Currently, approximately 40% of Japan’s employed workers are paid below-market salaries as contract and temporary part-time workers. Japanese companies have opted to control labor costs by hiring workers on a short-term or part-time basis at a low salary, while preserving their lifetime employment culture for their remaining full-time workers. The “equal pay for equal work” principle should help to address this labor inequality, resulting in more companies offering employees performance-based pay, more full-time positions and higher salaries. We also hope that these reforms will encourage more women to return to the workforce.
A second key economic reform is centered on corporate governance. Abe’s commitment to improving corporate governance standards in order to strengthen companies’ earning power has been a strong incentive for Japanese companies to use capital more efficiently. With guidelines set under the Japan Stewardship Code for institutional investors and increased appointments of independent directors on boards, we have already seen public companies improve shareholder returns, as measured by returns on equity, which have risen to almost 10% recently compared with just 5% five years ago.
Investors should keep in mind that no single policy can make significant improvements; rather, in aggregate, the structural reforms should help the country make steady progress.
Importantly, Prime Minister Abe has a high approval rating of over 60% as of December 2016. With strong public support and a stable political environment, the government should have ample time and support to implement the initiatives on their agenda.
3. What is the most important factor expected to influence Japanese stocks in 2017?
We believe one of the most important factors to influence Japanese stocks this year will be corporate earnings growth. If the Federal Reserve raises interest rates in 2017 as they are currently expected to do, it is likely that the Japanese yen will weaken further, boosting earnings growth for Japanese exporters, which account for a large portion of the Japanese market. In addition, we believe a prosperous export sector should generate positive spillover effects for domestic companies going forward.
We believe the estimated double-digit earnings growth for the fiscal year ended March 2017 may be exceeded and that earnings outlooks for Japanese companies could be revised upward over the next twelve months should the yen remain at current levels.
We believe it is important to remember that one of the reasons why profits growth in Japan is so strong today is that Japanese companies were forced to restructure their businesses in 2008-2011 in order to survive during a period of significant yen appreciation. Today, with a much weaker yen, many companies have seen profitability rise to record levels and have been generating abundant cash flows, which are being reinvested or set aside for potential future dividend payments.
4. Would you please comment on current market valuations?
We do not believe stocks in Japan are overpriced, rather we think they are fairly or slightly attractively valued, and we continue to find strong, well-run businesses at attractive valuations. Compared with international markets, Japanese equities do not look expensive. The Tokyo Price Index (TOPIX) was trading at 16x forward earnings as of December 31, 2016, while the S&P 500 Index was trading at almost 19x. Further, even though the TOPIX has roughly doubled in yen terms over the last four years, earnings per share of the TOPIX have also doubled over the same period, leaving price-to-earnings (PE) multiples no higher than they were in 2012 and near the low end of their historical range.