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Holly LaFon
Holly LaFon
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Hennessy Japan Fund 4th Quarter Commentary

Portfolio Managers Masakuzu Takeda and Tadahiro Fujimura discuss Japan’s economy, current stock valuations, the impact of the recent election in Japan and geopolitical events

January 11, 2018

In the following commentary, Portfolio Managers Masakuzu Takeda and Tadahiro Fujimura discuss Japan’s economy, current stock valuations, the impact of the recent election in Japan and geopolitical events, and make the case for investing in Japan.

  1. In the third quarter of 2017, Japan’s economy grew for the tenth straight quarter, the longest stretch of growth since 2007. What has been fueling this growth?

Gross domestic product (GDP) growth in Japan is being driven by three main factors:

  1. Growth in consumption
  1. Increasing capital investment
  1. Higher net exports

The labor market in Japan is very tight – the unemployment rate is just 2.8% - and so wages have been rising and consumer confidence has been moving steadily higher, all of which is encouraging Japanese consumers to spend more. Companies, meanwhile, have been investing more to automate their factories, reduce costs and

stay competitive. Investment has also been increasing in response to the reduction in corporate tax rates which Prime Minister Abe’s administration implemented from 2012 to 2016. And lastly, a weaker yen and solid economic growth in the countries that buy Japanese products, including the U.S., have benefited Japan’s exporters.

  1. The Japanese market has been rising – is the market looking expensive now? What do you think of Japanese stock valuations?

Japanese stocks are trading at about 15x 2017 earnings. This makes the Japanese market one of the cheapest major equity markets in the world today. The S&P 500, for example, is trading at about 21x 2017 earnings. So relative to international equities, Japanese stocks do not appear expensive at all. In fact, they might even be viewed as undervalued.

Relative to historical Japanese valuations, we believe the market today also offers good value. Over the past five years, corporate earnings per share and the TOPIX have both risen by about 120%. In other words, even though the Japanese market has risen, it has not seen any multiple expansion over this time period and is no more expensive today relative to earnings than it was five years ago. Japanese small-and large-cap companies are currently trading at approximately the same price-to-earnings, however, small-cap companies are growing faster at a rate of 12% versus 8% for large-caps.

And, if the government continues to focus on corporate governance reforms, we believe returns on capital will improve in Japan, encouraging investors to place higher valuations on Japanese equities than they do today. So, we believe there is opportunity for multiple expansion in the Japanese market over the long term.

  1. Prime Minister Abe and the LDP won the election in Japan in October. Could you tell us what that means for the political situation in Japan going forward?

The landslide victory in the Lower House for the incumbent LDP has given Prime Minister Abe an even stronger mandate to continue with his economic policies and structural reforms. The victory means that it is likely Abe will win the LDP leadership vote next year, preserving policy continuity in Japan probably until the end of

the decade. It also means that the current governor of the Bank of Japan will be reappointed next year, adding another welcome layer of stability for the economy and for the markets. We believe the election victory means that Japan can continue to move in the right direction with a pro-growth central bank and a reform-minded government.

  1. How are political events in North Korea affecting Asian markets?

While heightened tensions with North Korea have been widely discussed in the U.S. and Japan, they have not negatively impacted the Japanese economy nor the stock market. In fact, consumer sentiment in Japan from July through September has improved.

While the country’s proximity to North Korea may be concerning, South Korea’s economy appears stable, and its market performance over 2017 has been stronger than other Asian markets.

  1. Can you summarize the case for investing in Japan?

The bull case for Japan rests on three major factors. First, earnings are growing for Japanese companies. Over the last three years, earnings for both large- and small-cap companies in Japan have been growing at 10% annually. Growth is being powered by innovation, cost-cutting and growth in export sales. Second, Japanese stocks are selling at very reasonable valuations and with increasing returns on capital and a new focus on returning excess cash to shareholders, we believe valuations could move higher over time. Third, the political situation in Japan is stable and the recent election makes it very likely that the current, pro-

growth policies will remain in place. We believe these factors will continue to drive Japanese equity prices higher over the next few years.


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