Hit by the Covid-19 Delta variant and recent flooding, and with the Olympic Games done, Japanese equities have been stuck in a trading range since March. But as Lyxor’s Senior Cross-Asset Strategist Jean-Baptiste Berthon explains, there are reasons to be optimistic for the future, at least in the medium term.
Is the Japanese recovery over?
No, we expect Japan’s recovery to continue. For now, it would primarily rely on external demand and Capex.The Delta variant and the restrictions that co
me with it, and large recent flooding, are both likely to erode consumer confidence and delay by a quarter or so the recovery in consumption. Japanese households continue to hoard savings.
On the positive side, vaccinations are catching up with DM and the share of fully vaccinated elderly is now above 80%.
With the Tokyo Olympics over (save for the Paralympics), the focus will also turn to politics.The games did little to reverse PM Suga’s low polls, threatening his party leadership. However, his Liberal Democratic Party still largely dominates in polls, without any serious contender in the opposition, which makes any substantial policy shift unlikely.
How are Japanese equities faring in this context?
As a result of restrictions at home, and against China’s relative economic weakness, Japanese equities have been stuck in a trading range since March, substantially lagging other DM markets.
However, we remain optimistic in the medium-term. Corporate Japan has recorded remarkable fundamental progress. Japan companies’ strong operational leverage led to a higher relative rebound in their margins and ROE than in other DMs. This progress has not yet been priced, in our view: Japanese stocks are cheap both in absolute and relative basis.
Meanwhile Japan’s Covid picture is improving relative to the situation in other DM countries, providing a base for a catch-up in equities. Extra stimulus ahead of Japanese elections, and no immediate prospect of tapering by the Bank of Japan, should also comfort investors.
Besides, Japanese stocks’ even exposure to foreign and domestic activity, provide further diversification. Finally, with investors grossly underweight on this market, we see limited downside risks.
What risks should investors keep in mind?
The lingering Delta variant and restrictions could continue to feed a negative news flow and lead to a milder Q3 earnings season. A declining economic pulse abroad would be another risk to Japanese equities, especially if coming from the US or Asia.
Amid mixed tactical conditions, Japanese equities could continue to trade in a range, without a catalyst to kickstart the recovery that would lure foreign investors, who key to driving Japanese equity rebounds.
While we acknowledging a delayed recovery and the lack of pending buying catalyst, a favorable risk/reward keeps us structurally O/W.