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Diary of a fund manager - Japan Normal - 07.05.19

David Miller, Investment Director, Quilter Cheviot

In this week’s Diary, where next for Japan after decades of declining importance to investors, why the established car manufacturers have found a use for Tesla and why politics and public holidays are distorting economic statistics.

Ahead of another three day weekend for the UK, equity markets drifted and bonds moved lower along with gold. Specific to the UK, the pound strengthened and equities fell. Apple reported a decline in iPhone sales which had a knock on effect on earnings. The Argentinian 100 year bond issued in 2017 at $100 is now trading at $66 and the Savills house price heat map shows that the central London cold patch is spreading out across the South East. Value can be found in unexpected places. For example, Tesla will be paid €1.8 billion by Fiat Chrysler for CO2 credits. Meeting 2020 emissions targets comes at a price. UK politics moved further into obscurity with local election results reflecting disaffection with the two main parties. Next are the EU elections towards the end of May, which from a UK perspective show every sign of provoking the ultimate protest vote.

The economic statistics are all over the place, distorted by stockpiling, pre-Brexit in the UK and pre-trade war in the US. Also, Easter was late this year confusing first and second quarter comparisons with 2018. The most significant statistic released last week was the monthly US non-Farm payroll number which isregarded as a way of measuring the health of the world’s largest economy. The headline number showed an increase on 263,000 jobs in April, which suggests that all is well. However, on closer inspection, the majority of these new jobs were classified as government, administration, education and leisure. Sectors more directly related to economic growth showed less exuberance. No wonder Jay Powell, Chairman of the US Federal Reserve, was criticised for sending out mixed messages about the economy, interest rates and inflation. The ultimate opinion poll, otherwise known as the global financial market, settled on no change to interest rates and low inflation for the foreseeable future.

In the UK, commerce has been interrupted by three four day weeks in the last month, but in Japan they do it in a more well-ordered way. This Tuesday marks the end of, most likely, a once in a generation super-Golden Week. Between Saturday 27th April and Monday 6th May Japan has been on holiday. Golden Week happens each year when eight public holidays are compressed into four days: several Emperors birthdays, Greenery Day, Constitutional Memorial Day, Children’s Day and a Citizens Holiday were this year joined by two extra days to celebrate the succession of the new Emperor.

I have never visited Japan but have been an interested observer for many years. Back in the 1980s the Japanese miracle was in full swing. Production methods were exported to the West and even now remain hugely influential throughout the manufacturing supply chain. Thirty years back share prices just kept going up irrespective of profits and dividends were almost non-existent. Price earnings multiples ten times higher than seen in other major markets defied explanation and, in fact, no one really bothered other than to say that Japan was different. Asset price inflation was also rampant in the property sector with stories that the land around the Emperors palace was worth more than the whole of California common. As they say, strange times. Eventually the bubble burst and decades of deflation, negligible interest rates and stagnation have followed. Demographics added to the problem with an ageing population more interested in saving than consumption. The Nikkei Dow index is still only just above half the peak recorded at the end of 1989.

Looking beneath the surface does tell a more interesting story. Valuations are now ‘normal’ when compared to other leading markets, debt has moved from the corporate sector to government and many companies have cash on their balance sheets. This is very different to the US and Europe where both companies and governments continue to borrow as if there is no tomorrow. Hostile takeovers remain unpopular but can happen, and as a result companies are interested in keeping shareholders happy by paying more generous dividends than in the past. Ironically, the rest of the developed world has caught up with Japan when it comes to interest rates and demographics. Most importantly, the successful companies are those that have learned to cope with low economic growth and falling consumer prices. Progress has to come from innovation and the efficient use of resources. Complacency is not an option. Japan, for example, has become a centre of excellence for robotics and more generally artificial intelligence. That’s not to say that there aren’t problems, but who are we to cast the first stone. Investors, whether conventional stock pickers, activist hedge funds or private equity specialists, are interested for entirely rational reasons.             

Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

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