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Jupiter's Somerville backs Japanese domestic recovery

Jupiter's Somerville backs Japanese domestic recovery

A cut in Japan’s corporation tax and an increased allocation to equities by the government pension scheme will drive the stock market higher, according to Jupiter’s Simon Somerville.

Although Japan remains largely unloved by overseas investors who have been net sellers over the past year, the Jupiter Japan Income fund manager is backing Abenomics to work and has viewed the recent sell-off as a buying opportunity.

Much of the country’s recent underperformance has been driven by concerns about the impact of the introduction of a consumption tax on 1 April.

‘The biggest impact of the tax is the uncertainty it creates,’ Somerville (pictured) said. ‘The Japanese mindset is deflationary or of stable prices so the tax is a shock, but my view is that prime minister Shinzo Abe is very aware of this. The Japanese economy is much stronger than in 1997 when it last rose- then the banking sector was bankrupt.’

Official data released last week revealed the pending tax hike helped drive a shock 1.5% increase in first quarter GDP, in part led by a 2.1% rise in consumer spending. However, the rebound was also aided by a 4.9% surge in business capital spending, reflecting the robust health of corporate Japan.

Somerville pointed out that despite this, the Japanese stock market derated last year with all the performance coming from earnings per share growth. In contrast, European equity returns were purely driven by price-to-earnings (P/E) expansion, as were two thirds of US share price inflation.

‘Japanese equities are trading on historically low P/E ratios despite the fact earnings are growing,’ he said.

He believes further policy changes by Abe could provide a fillip for the stock markets, however. He said that talk of a cut in Japan’s corporation tax from 35% currently, one of the highest rates in the world, to 25% could have a massive impact.

‘Abe remains very popular, with an approval rating of over 50%, and he is committed to changing Japan. He absolutely understands that the success of the equity market is important to getting inflation back into the economy,’ Somerville said.

‘There is talk of lowering corporation tax to 25%. Abe is keen to make people more profit-focused and is focused on attracting companies to Japan, cutting red tape and making it easier to do business there. We could possibly see the first cut next year.’

Allied to this is the authorities’ determination to increase the $1.3 trillion Government Pension Investment Fund’s (GPIF) allocation to equities. Although the much-touted policy has taken time to bear fruit, Somerville pointed out that Abe has made changes to GPIF’s board, giving the government more influence and upping its focus on return on equity.

GPIF has around 16% of its assets held in domestic equities and owns around 8% of the entire stock market. If this was increased to 20%, the effect would be significant, Somerville said.

‘You know the changes are happening, it’s just a question of when and how they are implemented,’ he added.

Another factor shaping his optimism is what he perceives as improving corporate governance. He highlights research by CLSA, which revealed that year-to-date on 13 May, 164 Japanese companies have announced share buybacks – averaging around 3%. This is equivalent to around 1% of the Topix and a 3.3x rise, and is indicative of companies allocating capital more efficiently.

This has also bolstered his Japan Income fund. He points to a holding in Amada, a machinery manufacturer, which is a strong turnaround story. ‘It has really struggled for years because of the strength of the yen and unusually it has a 50% domestic customer base where capital expenditure has been moribund,’ he said.

‘Our view is that it would see a pick-up in orders, particularly domestically, and that is what has happened. [Last week] it announced profits were up 3.5x, albeit from a very low base, and it has forecast 73% growth this year.

‘It is raising its dividend by 30% and buying back around 3% of its shares and cancelling them. So we are getting earnings growth, capital efficiency and rising dividends.’

He singled out Message, a nursing home operator, as a structural growth story. ‘They are very localised and used by families who can’t afford in-house nursing care,’ he said. ‘It is playing into the demographics theme. Last year profits were up 24% and they are forecast to rise by 20% this year. It is still cheap on a valuation basis and has plenty of growing opportunities.

‘We have quite a domestic focus and believe the administration’s policies are really targeted at domestic Japan and getting growth back.’

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