20th November 2013
The tactical asset allocation stance since Q3 has been long USD and Japanese equities for a breakout to the 17-18k level on the Nikkei by end Q1 and a move toward my productivity adjusted 110 target on the JPY. While I’ve been on the road in Asia, those bets have been paying off, while China has surprised the skeptics by announcing a broadly coherent if as ever gradualist set of pro-market reforms to reduce some of the most glaring economic perverse incentives which have undermined productivity growth and the capital-output ratio. Japanese equities trade on a 14.5x forward PER with scope for a pick-up in ROE as well as renewed JPY weakness, but above all the much heralded domestic asset reallocation into inflation hedges. Not to mention real estate; I noted on my travels prominent ads in papers from HK to Singapore and even Bangkok for prime Tokyo condo developments, which would have been unthinkable a year ago but which the yen move and ultra-low JGB rates have turned into a compelling arbitrage versus overheated (and increasingly tightly regulated) local markets. But could domestic household formation also begin to drive real estate demand?
I got talking at an airport lounge to a very senior Japanese banker who is convinced that the Abe government will soon allow joint bank accounts, joint mortgages, and joint title to property for married couples, who for the first time would be treated as a single unit for tax purposes, all of which would boost the female workforce participation rate and potential growth. That wouldn’t be so much a ‘third arrow’ as an economic Scud missile, because the anachronistic social contract for educated women in Japan has been driving many adverse trends from a low marriage and fertility rate to the moribund real estate market. A surge in dual income, reproducing and mortgage borrowing households is one key to boosting real growth to anything like the 2% a year through 2020 forecast by the government, when underlying potential growth is estimated by the BOJ at only about 50bps.
Japan trades on a P/B of 1.3x but trailing ROE is only 7% – just a little over half the return from global equities as a whole. There has been some modest improvement in in the last few quarters, in part as the weaker yen has helped boost EPS. The consensus currently expects substantial improvement to about 9.5% over the next year. Japanese ROE is so far below other markets in part due to lower asset turn but above all because of lower margins. Structural reforms that work to improve the level of net income margins remain key to a sustained rerating of Japanese equities.