Higher productivity is the key word

BY YUTAKA UDA

Monthly Fund Commentary
14 Jul 2015

BY YUTAKA UDA

At the beginning of June, the Japanese market continued to rise maintaining the momentum from the end of May. However, the market was weighed down as the external market weakened due to expectations for an early advance in US interest rates and concerns regarding the Greek debt crisis.

A strengthening of the JPY also had a negative impact on the Japanese market. In contrast, good domestic numbers were released throughout the month, such as (i) an upward revision for capex for Jan-Mar; (ii) improvements in the May retail sales MoM; (iii) machinery orders were above consensus and (iv) forecast DI in the May Economy Watcher’s Survey advanced for the 6th consecutive month. In late June, optimism prevailed as the outlook for the domestic economy looked solid and the Greek debt issue seemed to show signs of progress. On the 24th, the Nikkei 225 rose to 20,952.7, exceeding the peak during the IT bubble for the first time in more than 18 years. However, the market fell back as concerns of default in Greece emerged again. As a result, the Nikkei closed the month at 20,235.7 (down 1.6% MoM) and the TOPIX at 1,630.4 (down 2.6% MoM), the first monthly decline in 2015.

In terms of sector performance of the 33 TSE sectors, 26 depreciated during the month. The best five performers were retail, fishery & agriculture, precision instruments, insurance and communication; the worst five being rubber, steel, marine transportation, mining and real estate.

The JPY started the month at 124.15 against the US Dollar and continued to depreciate towards 125.63. However, after the BoJ Governor Kuroda commented that the JPY was unlikely to weaken further in real effective terms, the JPY started to strengthen. The risk-off market environment kept the safe JPY high and ended the month at 122.50.

The net asset value per unit for the Nippon Growth (UCITS) Fund on a Japanese yen basis as of 30 June 2015 went down 3.8% compared with that of 29 May, while the TOPIX declined 2.6% during the same period. The fund put no new names into the portfolio with no stocks sold out.

The Japanese economy is accelerating its strong growth. The real GDP growth for Q1 2015 was revised and surged from a preliminary number of +2.4% QoQ annualised, to +3.9% due mainly to an upward revision in capital expenditure. Capex grew 11.0% QoQ annualised, significantly revised up from +1.4% based on initial data, contributing 1.5 percentage points to GDP growth. According to the BoJ’s quarterly economic survey “Tankan” in June, business conditions DI for large manufacturers improved to +15 from +12 in March and the DI for large non-manufacturers rose sharply from +19 to +23. The capex plans for large manufacturers in FY2015 were strongly revised up to +18.7% YoY from +5.0% YoY in March while large non-manufacturers increased plans from -4.1% YoY to +4.7% YoY. Separately the government approved “The 2015 update to the Japan revitalization strategy” on 30 June. The main point of this latest version is that the government emphasises supply-side reforms rather than measures originally employed to boost demand and eliminate deflation.

The new strategy explicitly seeks to respond to the emerging issue of supply constraints such as labour shortage and capacity constraint in the Japanese economy. Specifically the strategy aims to enhance overall productivity by expanding the use of IT and robots, encouraging greater innovation and venture business and strengthening corporate governance. The key word of the growth strategy is “higher productivity”. The government also released its latest fiscal consolidation plan, where it reiterated its goal to reduce Japan’s primary deficit/GDP ratio to -1% by 2018 and eliminate the deficit entirely by 2020. It is important that this goal can be achieved as the result of high growth rather than spending cuts. We are confident that the Japanese economy is entering into a high growth stage for FY2015-2018 derived from strong capital expenditure. Currently the market is being influenced by the developments in Greece, but in the longer term whatever happens in relation to Greece, the impacts will be limited for the global economy and insignificant for Japan, as far as this matter is contained within Greece. The market is also expected to regain strong momentum within a few weeks.

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.

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The views and statements contained herein are those of Evarich Asset Management in their capacity as Investment Advisers to the Fund as of 10/07/15 and are based on internal research and modelling.