CAPEX to lead a strong economic recovery

BY YUTAKA UDA

Monthly Fund Commentary
15 Apr 2015

BY YUTAKA UDA

In March the Japanese market showed a marginal rise by the end of the month with the Nikkei 225 hitting above 19,000 for the first time in 15 years on 12 March and at one point aiming towards 20,000.

However, the market declined sharply from 19,778 on 23 March towards 19,099 within 5 days, the Nikkei 225 closed the month at 19,207 (up 2.2% MoM) and the TOPIX at 1,543.1 (up 1.3% MoM). In terms of sector performance, of the 33 TSE sectors, 22 appreciated. The best five performers were miscellaneous manufacturing, pharmaceuticals, services, retail and foods. The worst five performers were steel, mining, pulp & paper, fishery & agriculture and marine transportation.

At the beginning of the month, a weakening Yen supported the market but was not showing much rise due to profit taking from concerns of overheating prices. In mid-March, sentiment improved as news flows reported  the intention of major companies to introduce significant salary increases. In addition, buying, aiming for fiscal yearend dividends occurred, and pushed the market further. However, by the end of the month, profit taking became more evident as US indicators were worse than expected and caution arose for an overheated market. The market dropped further after exdividend day.

The Yen started the month from 119.63 against the USD, and depreciated to 121.45 but then settled at 120.13 by the end of March. The USD appreciated due to speculation for rise in US interest rates in the future, but rose further after the ECB’s decision to start buying government bonds of European countries on 9 March.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese Yen basis as of 31 March 2015 declined 0.8% compared with that of 27 February, while the TOPIX went up 1.3% during the same period. The Fund put one new name (Otsuka Corp) into the portfolio with one stock (Asahi Kasei) sold out.

Recent economic data sent a mixed signal to the market although underlying trends remain fairly good. Industrial production in February declined 3.4% MoM albeit a market consensus of -1.9%. The government survey suggests that industrial production in March would continue to decline 2.0% MoM but would increase 3.6% MoM in April. According to the BoJ’s quarterly economic survey “Tankan” for March, announced on 1 April, the business conditions diffusion index (DI) for large manufacturers stood at 12, unchanged from the December survey, and the DI for large non-manufacturers increased to 19 from 17. Whilst the recovery of export oriented industries lagged, reflecting slower growth in Chinese and US economies, business sentiment in domestic demand related industries continued to improve. The survey suggests that the DI for large manufacturers for June would decline to 10, from current level of 12, but large manufacturers utilised a very conservative USD/JPY assumption of 111.8 for FY 3/2016 in their business plan. The Investment Adviser believes there will be room for the business conditions and corporate profits to be revised upward in the future. Employment conditions DI for March clarified tougher labour shortages for all industries and all sizes to -17 from -15 in December. With the employment conditions DI for June expected to decline to -18, and the production capacity DI expected to decline from -1 to -2, an upward pressure on prices and wages still remains despite the recent slowdown in CPI data. The Investment Adviser thinks that capital expenditure will expand dramatically across the industries to seek higher productivity for the coming four years and will act as a leading engine for Japan’s strong economic recovery. Although the market went up almost 10% in 1Q 2015, there should be much more upside potential as valuations remain cheap, and a surprising and remarkable change of investors perception regarding the Japanese economic outlook for the medium terms is expected to take place.

Construction and real estate sectors should have more upside potential with replacement demands expanding sharply and the 2020 Tokyo Olympics related projects starting. The Fund is increasing allocation to the machinery sector with the conviction that capex will have to grow to seek higher productivity. The Fund will keep a high weighting in banks and commerce (mainly trading companies) sectors. On the other hand, defensive and technology sectors should be avoided as these have high valuations and lower growth potential.

The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Fund as of 10/04/15 and are based on internal research and modelling.