A pick-up in vaccination rates, favorable global economic conditions and reasonable valuations set up Japan as one of our highest conviction equity calls.
As the Olympics kick off in Tokyo, the empty stands facing athletes are a clear sign that Japan’s stop-start re-opening efforts and slow vaccine rollout hampered its recovery.
However, there are signs the situation is improving, which leads us to take a more positive view on the Japanese equity market.
We see opportunities emerging from two areas:
First, Japan’s vaccination rate is rapidly improving, opening up the possibility for an earnings rebound. Second, Japan has broadly underperformed the rest of the world, opening up the potential for a catch-up trade on relatively attractive valuations.
We now know that vaccinations are the critical enabler allowing economies to make sustained, durable economic recoveries. While Japan broadly lagged the rest of the world due to a slower vaccine approval process, recently the pace of vaccinations has meaningfully accelerated.
Vaccination doses are now averaging over 1m per day, and in short order over 30% of the Japanese population have now had at least one dose, creating the potential that Japan could surpass Europe’s vaccination rates by October. Furthermore, surveys have shown that the Japanese population has a relatively high willingness to get vaccinated, which could continue to support the vaccination push.
Having underperformed major developed equity markets such as the S&P500 and Eurostoxx 600 by 7-9% year-to-date, there seems to be a tactical catch-up opportunity for Japanese equities over the next six months.
Rapidly improving vaccination rates provide a key catalyst. We expect that the spotlight of the re-opening trade could potentially shift from Europe to Japan in the coming months. The combined effects from a robust external growth environment and the unleashing of significant domestic pent-up demand could provide a substantial tailwind for Japanese corporates in the second half of 2021 and drive outperformance.
Furthermore, having reached a record level in share buybacks totaling JPY 6.6T in 2019, we could see a resumption in capital returns as management teams become comfortable that COVID-19 risks will moderate towards the latter part of 2021.
Since March, we have already seen consensus earnings estimates for Japanese companies rise by 6%, and the set-up is favorable for further earnings upgrades. In addition, an estimated 70% of Japanese corporate earnings are geared to exports priced mainly in U.S. dollars, a strengthening dollar would be another positive for earnings.
Finally, low interest rates have been a contributing factor in driving valuations above historical averages across a number of equity markets. With the TOPIX trading at a valuation of just 15x forward P/E, largely in line with its 15-year historical average, the Japanese equity market appears underpriced and compelling at current levels. To capitalize on this opportunity, investors could focus on actively selecting the beneficiaries of strong global manufacturing demand, structural megatrends in factory automation and technology, and pent-up domestic consumption. As the Olympics kick off in Tokyo, the empty stands facing athletes are a clear sign that Japan’s stop-start re-opening efforts and slow vaccine rollout hampered its recovery.
However, there are signs the situation is improving, which leads us to take a more positive view on the Japanese equity market.
We see opportunities emerging from two areas:
First, Japan’s vaccination rate is rapidly improving, opening up the possibility for an earnings rebound. Second, Japan has broadly underperformed the rest of the world, opening up the potential for a catch-up trade on relatively attractive valuations.
We now know that vaccinations are the critical enabler allowing economies to make sustained, durable economic recoveries. While Japan broadly lagged the rest of the world due to a slower vaccine approval process, recently the pace of vaccinations has meaningfully accelerated.
Vaccination doses are now averaging over 1m per day, and in short order over 30% of the Japanese population have now had at least one dose, creating the potential that Japan could surpass Europe’s vaccination rates by October. Furthermore, surveys have shown that the Japanese population has a relatively high willingness to get vaccinated, which could continue to support the vaccination push.
Having underperformed major developed equity markets such as the S&P500 and Eurostoxx 600 by 7-9% year-to-date, there seems to be a tactical catch-up opportunity for Japanese equities over the next six months.
Rapidly improving vaccination rates provide a key catalyst. We expect that the spotlight of the re-opening trade could potentially shift from Europe to Japan in the coming months. The combined effects from a robust external growth environment and the unleashing of significant domestic pent-up demand could provide a substantial tailwind for Japanese corporates in the second half of 2021 and drive outperformance.
Furthermore, having reached a record level in share buybacks totaling JPY 6.6T in 2019, we could see a resumption in capital returns as management teams become comfortable that COVID-19 risks will moderate towards the latter part of 2021.
Since March, we have already seen consensus earnings estimates for Japanese companies rise by 6%, and the set-up is favorable for further earnings upgrades. In addition, an estimated 70% of Japanese corporate earnings are geared to exports priced mainly in U.S. dollars, a strengthening dollar would be another positive for earnings.
Finally, low interest rates have been a contributing factor in driving valuations above historical averages across a number of equity markets. With the TOPIX trading at a valuation of just 15x forward P/E, largely in line with its 15-year historical average, the Japanese equity market appears underpriced and compelling at current levels. To capitalize on this opportunity, investors could focus on actively selecting the beneficiaries of strong global manufacturing demand, structural megatrends in factory automation and technology, and pent-up domestic consumption.
However, there are signs the situation is improving, which leads us to take a more positive view on the Japanese equity market.
We see opportunities emerging from two areas:
First, Japan’s vaccination rate is rapidly improving, opening up the possibility for an earnings rebound. Second, Japan has broadly underperformed the rest of the world, opening up the potential for a catch-up trade on relatively attractive valuations.
We now know that vaccinations are the critical enabler allowing economies to make sustained, durable economic recoveries. While Japan broadly lagged the rest of the world due to a slower vaccine approval process, recently the pace of vaccinations has meaningfully accelerated.
Vaccination doses are now averaging over 1m per day, and in short order over 30% of the Japanese population have now had at least one dose, creating the potential that Japan could surpass Europe’s vaccination rates by October. Furthermore, surveys have shown that the Japanese population has a relatively high willingness to get vaccinated, which could continue to support the vaccination push.
Having underperformed major developed equity markets such as the S&P500 and Eurostoxx 600 by 7-9% year-to-date, there seems to be a tactical catch-up opportunity for Japanese equities over the next six months.
Rapidly improving vaccination rates provide a key catalyst. We expect that the spotlight of the re-opening trade could potentially shift from Europe to Japan in the coming months. The combined effects from a robust external growth environment and the unleashing of significant domestic pent-up demand could provide a substantial tailwind for Japanese corporates in the second half of 2021 and drive outperformance.
Furthermore, having reached a record level in share buybacks totaling JPY 6.6T in 2019, we could see a resumption in capital returns as management teams become comfortable that COVID-19 risks will moderate towards the latter part of 2021.
Since March, we have already seen consensus earnings estimates for Japanese companies rise by 6%, and the set-up is favorable for further earnings upgrades. In addition, an estimated 70% of Japanese corporate earnings are geared to exports priced mainly in U.S. dollars, a strengthening dollar would be another positive for earnings.
Finally, low interest rates have been a contributing factor in driving valuations above historical averages across a number of equity markets. With the TOPIX trading at a valuation of just 15x forward P/E, largely in line with its 15-year historical average, the Japanese equity market appears underpriced and compelling at current levels. To capitalize on this opportunity, investors could focus on actively selecting the beneficiaries of strong global manufacturing demand, structural megatrends in factory automation and technology, and pent-up domestic consumption. As the Olympics kick off in Tokyo, the empty stands facing athletes are a clear sign that Japan’s stop-start re-opening efforts and slow vaccine rollout hampered its recovery.
However, there are signs the situation is improving, which leads us to take a more positive view on the Japanese equity market.
We see opportunities emerging from two areas:
First, Japan’s vaccination rate is rapidly improving, opening up the possibility for an earnings rebound. Second, Japan has broadly underperformed the rest of the world, opening up the potential for a catch-up trade on relatively attractive valuations.
We now know that vaccinations are the critical enabler allowing economies to make sustained, durable economic recoveries. While Japan broadly lagged the rest of the world due to a slower vaccine approval process, recently the pace of vaccinations has meaningfully accelerated.
Vaccination doses are now averaging over 1m per day, and in short order over 30% of the Japanese population have now had at least one dose, creating the potential that Japan could surpass Europe’s vaccination rates by October. Furthermore, surveys have shown that the Japanese population has a relatively high willingness to get vaccinated, which could continue to support the vaccination push.
Having underperformed major developed equity markets such as the S&P500 and Eurostoxx 600 by 7-9% year-to-date, there seems to be a tactical catch-up opportunity for Japanese equities over the next six months.
Rapidly improving vaccination rates provide a key catalyst. We expect that the spotlight of the re-opening trade could potentially shift from Europe to Japan in the coming months. The combined effects from a robust external growth environment and the unleashing of significant domestic pent-up demand could provide a substantial tailwind for Japanese corporates in the second half of 2021 and drive outperformance.
Furthermore, having reached a record level in share buybacks totaling JPY 6.6T in 2019, we could see a resumption in capital returns as management teams become comfortable that COVID-19 risks will moderate towards the latter part of 2021.
Since March, we have already seen consensus earnings estimates for Japanese companies rise by 6%, and the set-up is favorable for further earnings upgrades. In addition, an estimated 70% of Japanese corporate earnings are geared to exports priced mainly in U.S. dollars, a strengthening dollar would be another positive for earnings.
Finally, low interest rates have been a contributing factor in driving valuations above historical averages across a number of equity markets. With the TOPIX trading at a valuation of just 15x forward P/E, largely in line with its 15-year historical average, the Japanese equity market appears underpriced and compelling at current levels. To capitalize on this opportunity, investors could focus on actively selecting the beneficiaries of strong global manufacturing demand, structural megatrends in factory automation and technology, and pent-up domestic consumption.
This is an Olympics like no other. While arenas were packed to the brim with cheering fans for the Euro 2020 and NBA finals, sports venues across Japan will be devoid of spectators during the Olympics, casting a visible cloud over Japan’s re-opening efforts while other parts of the developed world move on. This contrast has been the narrative that characterized much of Japan’s experience with COVID-19. Stop-start re-opening efforts and a slow vaccine rollout are hampering the country’s recovery and causing economic performance and financial markets to lag relative to other developed markets.
However, there are signs the situation is improving, which leads us to take a more positive view of the Japanese market. We see opportunities emerging from two areas: first, Japan’s vaccination rate is rapidly improving (see chart below), opening up the possibility for an earnings rebound. Second, Japan has broadly underperformed the rest of the world, opening up the potential for a catch-up trade on relatively attractive valuations.
Vaccinations were off to a slow start, but rapidly catching up
We now know that vaccinations are the critical enabler allowing economies to make sustained, durable economic recoveries. Japan’s market has underperformed over the past few months as cases spiked and vaccination rates lagged behind the rest of the developed world.
However, there is reason for optimism on this front. Japan is unique in that it generally requires more clinical trials than most countries before vaccines can be approved. This relatively slow approval process held back vaccinations while the rest of the world was ramping up. Japan only approved the Moderna and AstraZeneca vaccines in May, and it was only at the end of June that they started vaccinating under-65-year-olds. Since then, the pace of vaccinations has meaningfully accelerated.
Recent reports suggest that Japan has secured enough doses to cover the entire population by the end of the year and set a target of completing vaccinations for all willing residents by November1. Vaccination doses are now averaging over one million per day, and in short order over 30% of the Japanese population have now had at least one dose, creating the potential that Japan could surpass Europe’s vaccination rates by October. Furthermore, surveys have shown that the Japanese population has a relatively high willingness to get vaccinated (see chart below), which could continue to support the vaccination push.
Japan’s multi-year efforts to bolster its athletic programs in the lead-up to the Olympics might surprise the odds in terms of the medal count. Similarly, Japan’s ongoing vaccination efforts and favorable global economic and market dynamics are setting the stage for catch-up and outperformance in the coming quarters, making Japan one of our highest conviction equity calls.
Temporary manufacturing disruptions set to ease
In addition to the slow pace of vaccinations hindering the recovery in services and consumption, Japan’s manufacturing and exporting sector, which have been bright spots across the rest of North Asia, has been severely impacted by semiconductor shortages. This has forced production cuts as inventories are exhausted, and given the outsized influence of the auto sector in Japan’s economy, it has resulted in negative spillover effects onto other industries.
However, there are hopeful signs that shortages will soon ease. Taiwan Semiconductor Manufacturing Company (TSMC) reported that it expects the chip shortage that has impacted automakers to start easing in the next few months following a ramp-up in production. As semiconductor supply constraints ease and global cyclical demand remains strong, there are potential upsides in auto production and associated sectors. It should be noted that Japan also plays a key role as a producer of semiconductor manufacturing equipment. As capex ramps up in anticipation of structurally stronger semiconductor demand, exports of chip manufacturing equipment have been and will likely continue to be a bright spot in Japanese manufacturing.
Do the Olympics matter? (Or rather, does the lack of spectators matter for the economic outlook?)
With so much global attention on the Games, it is worthwhile to question if they are beneficial from an economic and financial perspective. Recent media attention has focused on the lack of an Olympics-related boost due to a lack of spectators. However, most research shows that the majority of the economic benefit comes before the games, not the actual event itself. This is true not only from an investment perspective due to increased infrastructure investment leading up to the Games, but from a boost in tourism in the years between winning the bid and holding the Games. Indeed, most of Japan’s recent gains in tourism came soon after winning the 2020 Olympics bid.
Why Japan is one of our highest conviction markets
Having underperformed major developed equity markets such as the S&P 500 and Eurostoxx 600 by 7-9% year-to-date, there seems to be a tactical catch-up opportunity for Japanese equities over the next six months. Rising COVID-19 cases in late March coupled with low vaccination rates in Japan have driven significant negative sentiment towards the equity market, which seems overdone.
While Japan’s domestic economy is impacted by the current State of Emergency in several major cities, earnings for listed Japanese corporates are actually more sensitive to global demand. In particular, there is a relatively high correlation between global manufacturing activity levels and Japanese earnings revisions. Although global activity levels are expected to moderate, we expect them to remain in expansionary territory. Historically, global manufacturing PMI levels above 52 coincide with net positive earnings revisions for Japanese companies. Since March, we have already seen consensus earnings estimates for Japanese companies rise by 6%, and with relatively conservative guidance for the upcoming fiscal year set by management teams, the set-up is favorable for further earnings upgrades as we progress through upcoming earnings seasons.
In addition, a potential tailwind could also come from a modestly stronger USD. With an estimated 70% of Japanese corporate earnings geared to exports priced mainly in U.S. dollars, a strengthening dollar would be another positive to earnings.
Another powerful catalyst could be the rapidly improving COVID-19 vaccination rates. In addition, with the Japanese General Election to be held by October, there is strong motivation for this vaccination momentum to continue and for the domestic economy to re-open 1-2 months beforehand. We expect that the spotlight of the re-opening trade could potentially shift from Europe to Japan in the coming months. The combined effects from a robust external growth environment and the unleashing of significant domestic pent-up demand could provide a substantial tailwind for Japanese corporates in the second half of 2021 and drive outperformance. Furthermore, having reached a record level in share buybacks totaling JPY 6.6T in 2019, we could see a resumption in capital returns as management teams become comfortable that COVID-19 risks will moderate towards the latter part of 2021.
Finally, low interest rates have been a contributing factor to driving valuations above historical averages across a number of equity markets. With the TOPIX trading at a valuation of just 15x forward P/E, largely in line with its 15-year historical average, we see a compelling opportunity at current levels. Like most developed markets, earnings growth is expected to be strong in 2021 due to base effects, but the delayed re-opening of the domestic Japanese economy could drive another year of mid-teens earnings growth in 2022. At current levels, the Japanese equity market appears underpriced.
Investment Implications
To capitalize on this opportunity, investors could focus on actively selecting the beneficiaries of strong global manufacturing demand, structural megatrends in factory automation and technology, along with pent-up domestic consumption.
Footnotes
1Source: Bloomberg Finance L.P. https://www.bloomberg.com/news/articles/2021-06-09/japan-s-suga-wants-to-inoculate-those-seeking-shots-by-oct-nov
The Standard and Poor’s 500 Index is a capitalization-weighted index of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% of available market capitalization.
The Stoxx Europe 600 Index has 600 fixed components and represents large, mid, and small capitalization companies across 17 countries of the European region.
The Tokyo Stock Price Index, commonly known as TOPIX, is an important stock market index for the Tokyo Stock Exchange in Japan, tracking all domestic companies of the exchange's First Section.
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