Schroders
Updated 26 Apr 2024
Save Article

Disclaimer

This is a non-independent marketing communication commissioned by Schroder Investment Management. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

The Japanese equity market has shown encouraging strength so far in 2024, with the Nikkei 225 finally exceeding the bubble-era high seen in December 1989. Robust corporate fundamentals, improved governance standards and increasing foreign demand have all contributed to the stock market’s strength, but a key question for investors now must be whether the market can continue to forge higher.

Are the conditions now in place for a bold new era of prosperity for the Japanese stock market? Or should investors be thinking of taking profits in Japan, given the market’s fresh heights? We aim to answer these questions below, with contributions from the portfolio manager of Schroder Japan Trust plc, Masaki Taketsume.

What’s been driving Japanese stocks higher?

Many factors have contributed to the Japanese stock market’s recent strength, with growing earnings and improving corporate fundamentals among them. Profits from Japanese companies have been generally heading in the right direction, with the most recent quarterly earnings season seeing plenty of upside revisions to profit forecasts. In aggregate, this has meant earnings have also reached record highs and, as the chart below illustrates, this is forecast to continue in the years ahead.

AGGREGATE EARNINGS

Graph showing a strong trend for share buyback

Source: Nomura Research as at February 2024 (EPS = earnings per share). The forecasts represented by the green bars are not a guarantee of any future performance and there is no assurance that the forecasts will be realised.

The performance of domestically-oriented companies has been particularly impressive, with many companies demonstrating strong demand and displaying signs of regained pricing power (the ability to raise prices in response to inflation). After years of entrenched deflation, the importance of this should not be underestimated, as Masaki explains:

“This is an environment in which Japanese companies appear to be regaining pricing power for the first time in decades. When coupled with improved consumer purchasing power through wage increases, this should drive healthy levels of corporate earnings growth. An element of these higher profits can then be recycled back into the economy through further wage increases, driving a positive cycle of broader economic progress that has been largely absent from Japan for a generation.”

Meanwhile, thanks to the ongoing efforts of the Tokyo Stock Exchange, corporate governance reforms have continued. After a long period of overseas apathy towards Japanese equities, these reforms are now resulting in growing interest from the global investment community. Notably, share buybacks have continued to increase as the market has risen and we would expect this to continue as more and more companies are compelled to take steps to improve their returns and address their persistent undervaluation.

Chart showing that aggregate earnings have hit an all time high

Chart showing that aggregate earnings have hit an all time high

Source: Quick, SMBC Nikko as at 29 February 2024, based on TOPIX constituents.

A good example from the Schroder Japan Trust portfolio of a business where ongoing engagement efforts have resulted in a change of attitude from management, is the logistics services business Sankyu. Masaki and his team have been engaging with Sankyu’s management and its investor relations team since 2017, but stepped up their efforts in 2021, as the company was preparing its new mid-term strategy. They have engaged across a range of environmental, social and governance factors such as targets for CO2 emissions and its proportion of female managers, but the primary focus has been on encouraging a more appropriate shareholder remuneration policy. Masaki elaborates:

“As Sankyu’s balance sheet has strengthened in recent years, we have pressed for more transparency on its dividend policy, a higher pay-out ratio and encouraged management to consider a share buyback programme. This was duly announced with the company’s full year results in May 2021, and we have subsequently seen progressive increases in the dividend and a commitment to increase the payout ratio to 40% from 20% in 2018. Sankyu has also announced its long-term strategy to 2030, which demonstrates the company’s commitment to sustainability and diversity, as well as to returning profits to shareholders.”

The stock market has rewarded Sankyu’s progress with a progressively higher share price over the last three years, albeit it remains slightly below the high reached in 2018.

Should investors be thinking about taking profits?

There is, perhaps, reason for caution in the near-term, given the speed and nature of the recent rally. Large cap stocks, which have ample liquidity, have continued to outperform. As a result, the valuations of many large companies, especially those in the Nikkei 225 index, have become somewhat stretched. From here, Masaki expects Japanese market leadership to migrate towards mid and small sized companies. This bodes well for the Schroder Japan Trust, which is biased towards this part of the market, where the team finds more attractive valuations, higher quality businesses and superior growth potential.

Other reasons for caution may include developments in currency markets and monetary policy. The Japanese yen has depreciated sharply again and, with the government and the Bank of Japan monitoring the situation closely, the possibility of an unexpected change in policy settings cannot be ruled out.

Much may depend on the outcome of this year’s ‘Shunto’, the big spring wage negotiations. Preliminary reports suggest that the average increase in wages in this year’s negotiations exceeded 5% for the first time in 30 years. Although this is further evidence of the return of sustained inflation in the Japanese economy, and therefore a positive for the long-term fundamental investment case for Japanese equities, it could impact sentiment in the near term, particularly if it convinces the Bank of Japan to tighten monetary conditions by moving away from ‘yield curve control’.

Reasons for longer-term positivity

Despite these near-term vulnerabilities, Masaki believes there are many reasons to believe that we may have entered a period of sustained long-term outperformance from the Japanese stock market. He believes Japan provides one of the most attractive opportunities to be found anywhere in the world. This is supported by solid corporate fundamentals, the presence of positive inflation and the return of pricing power for many Japanese companies.

Meanwhile, corporate governance reforms are likely to remain a structural driver, with investors, companies and regulators working together to raise governance standards, to improve returns and growth prospects. The success of these initiatives is increasingly clear, but there remains scope for considerable further positive progress as this corporate governance revolution unfolds.

In combination, these factors have activated renewed appetite for Japanese equity from global investors and this demand should continue to grow as the positive domestic story becomes better understood. The overall valuation of the market looks reasonable, but this masks a considerable divergence between the larger companies that have become relatively fully-priced, and the smaller companies to which the Schroder Japan Trust portfolio is primarily exposed, where valuations are, in general, much more appealing.

Masaki believes that the Japanese market as a whole can make good long-term progress from here, but this represents a particularly exciting environment for active, high conviction stock pickers. By focusing the portfolio toward undervalued businesses with strong growth prospects and the potential to improve returns, Masaki is very confident in the opportunity that lies ahead for investors in the Trust.

Fund Risk Disclosures: Schroder Japan Trust plc

  • Concentration risk: The company may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the company, both up or down, which may adversely impact the performance of the company.
  • Currency risk: The company can be exposed to different currencies. Changes in foreign exchange rates could create losses.
  • Concentration risk: The fund may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the fund, both up or down.
  • Currency risk: The fund may lose value as a result of movements in foreign exchange rates, otherwise known as currency rates.
  • Derivatives risk: Derivatives, which are financial instruments deriving their value from an underlying asset, may be used to manage the portfolio efficiently. The fund may also materially invest in derivatives including using short selling and leverage techniques with the aim of making a return. A derivative may not perform as expected, may create losses greater than the cost of the derivative and may result in losses to the fund.
  • Gearing risk: The company may borrow money to make further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase by more than the cost of borrowing, or reduce returns if they fail to do so. In falling markets, the whole of the value in that investment could be lost, which would result in losses to the fund.
  • Liquidity risk: In difficult market conditions, the fund may not be able to sell a security for full value or at all. This could affect performance and could cause the fund to defer or suspend redemptions of its shares, meaning investors may not be able to have immediate access to their holdings.
  • Operational risk: Operational processes, including those related to the safekeeping of assets, may fail. This may result in losses to the fund.
  • Performance risk: Investment objectives express an intended result but there is no guarantee that such a result will be achieved. Depending on market conditions and the macro economic environment, investment objectives may become more difficult to achieve.
  • Counterparty risk: The fund may have contractual agreements with counterparties. If a counterparty is unable to fulfil their obligations, the sum that they owe to the fund may be lost in part or in whole.
  • Market risk: The value of investments can go up and down and an investor may not get back the amount initially invested.

For help in understanding any terms used, please visit address https://www.schroders.com/en/insights/invest-iq/investiq/education-hub/glossary/

We recommend you seek financial advice from an Independent Adviser before making an investment decision. If you don't already have an Adviser, you can find one at www.unbiased.co.uk or www.vouchedfor.co.uk. Before investing in an Investment Trust, refer to the prospectus, the latest Key Information Document (KID) and Key Features Document (KFD) at www.schroders.co.uk/investor or on request.

Important information

This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.

The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.

Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.

Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.

Welcome to Kepler Trust Intelligence

Please enter a valid email address
{{item.msg}}
Please enter a valid password
{{item.msg}}
Please enter a valid email address
{{item.msg}}
Please check your email. If an account exists you'll be sent instructions on how to reset your password.
To ensure that we are able to provide content which is appropriate for you, please tell us a little about yourself.
Please choose an option
{{item.msg}}
Please enter a company name
{{item.msg}}
Please enter a location name
{{item.msg}}
Please choose an option
{{item.msg}}
Please enter a platform
{{item.msg}}
Please choose an option
{{item.msg}}
Please enter a trust
{{item.msg}}
?
The information contained herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in the United States to or for the benefit of any United States person (being residents of the United States or partnerships or corporations organised under the laws thereof). The investment funds referred to herein have not been registered in the United States under the Investment Company Act of 1940 and units or shares of such funds are not registered in the United States under the Securities Act of 1933.
Please confirm
{{item.msg}}
Please select an option
{{item.msg}}
See benefits
A free Kepler Trust Intelligence account allows you to access premium content including the ‘Kepler View’ – our verdict on the trusts we cover – and historical research so you can see how our view has changed over time. An account also unlocks useful facilities like the ‘follow’ button which lets you keep track of the trusts you’re interested in and as a logged in user you can also download PDFs of our research, and choose the layout of the page you’re reading to suit your preference. We will not share your details unless you give us permission to do so, and we won’t bombard you with emails – we only send one a week.
Please select an option
{{item.msg}}
Please enter your first name
{{item.msg}}
Please enter your last name
{{item.msg}}
Please enter a valid email address
An account already exists with this email - have you forgotten your password?
{{item.msg}}
Please enter a valid password
{{item.msg}}
Please enter a valid password
{{item.msg}}
How will this information be used? Your answers help us to tailor our content to relevant investment trusts, and to ensure that the asset allocation and portfolio strategy research we produce is appropriate to our userbase.
Our Website uses Cookies Cookies are small text files held on your computer. They allow us to give you the best browsing experience possible and mean we can understand how you use our site. Some cookies have already been set. You can delete and block cookies, but parts of our site won’t work without them. By using our website you accept our use of cookies. For further information please refer to the Kepler Privacy Notice.
Need help?

One more thing...

Did you know, you can 'follow' individual trusts on Kepler Trust Intelligence? Use the functions below to set up alerts and we'll send you research and updates on your chosen trusts.

Suggested trusts to follow

Browse all funds
Need help?
Current Site Kepler Trust Intelligence is produced by the investment companies team at Kepler Partners and is the UK’s premier source of detailed qualitative research on investment trusts. Absolute Hedge is a market leading UCITS research database providing proprietary research on funds, themes and strategies in the UCITS space. Kepler Liquid Strategies is a Dublin domiciled UCITS fund platform featuring a number of best-of-breed fund managers. Kepler Partners is a corporate advisory and asset raising boutique specialising in the regulated funds market in Europe and investment trusts in the UK.