The stars are aligning for Japanese companies from a global and domestic macroeconomic perspective. Ernst Glanzmann and Lukas Knüppel, Investment Directors, and Katsuya Takeuchi, Investment Analyst, Japan Equities, note that at the same time the market and many investors have not fully recognised the shift in earnings momentum towards quality growth companies that is occurring.
25 September 2024
In the aftermath of the significant economic distortions caused by Covid-19, the global economy is now largely normalising. This end to an unprecedented period presents a crucial juncture for Japanese equity investors to reassess their portfolios and ask: Which companies and sectors are best-positioned to drive future earnings growth in the post-pandemic era?
Stalling earnings growth in the value sector
After strong performance from value stocks over the past three years, momentum is now starting to stall, as indicated by a decline in earnings growth within key value sectors (in each of which our strategy is underweight):
- Automotive sector: The volume rebound from production shortages during the Covid-19 pandemic has largely run its course and industry discounts are rising. Additionally, the sector that benefited most from yen weakness is unlikely to continue seeing these advantages, as the period of severe yen weakness appears to be over.
- Trading houses: Large trading companies have enjoyed substantial earnings growth due to pandemic-induced dislocations in commodity markets and supply chains. However, these disruptions have now largely normalised, leading to a slowdown in growth.
- Banking sector: The strong performance in the banking sector was largely driven by expectations of a monetary policy shift by the Bank of Japan (BoJ). With these expectations now mostly priced in, the sector's momentum could be waning.
Return of growth momentum
In contrast, we see a clear shift in earnings growth momentum towards leading quality companies with long-lasting growth potential, on which we focus, as confirmed in the most recent earnings season.
This shift is driven by a combination of cyclical and structural factors:
- Industrial holdings: Our industrial holdings are seeing an earnings recovery after a significant inventory correction, which followed the rapid cooling of the heightened demand experienced during the pandemic. Additionally, a cyclical recovery is underway, with the potential for further expansion in many sub-sectors.
- Healthcare equipment & service: The normalisation from Covid-related disruptions is benefiting our healthcare positions, leading to renewed earnings growth.
Structural growth themes driving long-term earnings growth
Beyond the cyclical recovery, we are strategically positioned with the aim of capitalising on the structural growth themes driving long-term success. Key trends such as digitalisation, artificial intelligence (AI), aging population, rising labour shortages and the emergence of the middle class in emerging markets are coming back to the forefront. Our investments in sectors like semiconductor production equipment, factory automation, robotics, medical equipment and digital payments are well aligned with these themes.
As an example, the increasing global labour shortages are accelerating the adoption of automation and robotics, allowing industries to raise efficiency and productivity. Simultaneously, digitalisation is driving the demand for advanced technologies, positioning our holdings in semiconductor production equipment to benefit from this ongoing shift. As AI and big data continue to reshape the world, we believe our portfolio companies are set to thrive in this increasingly tech-driven landscape.
In addition, the structural trends of an ageing population and a growing emerging middle class in developing countries are creating significant opportunities in the healthcare and consumer markets, providing sustainable growth for our investments in areas such as medical devices and personal hygiene. This blend of cyclical recovery and structural growth trends should position our strategy to capitalise on these critical drivers, ensuring long-term profitability and resilience.
Our positioning in these sectors is driven by our conviction that Japanese companies are highly competitive and world class in these areas. We exclusively invest in companies with the potential to lead in their respective fields. This leadership is often rooted in their outstanding proprietary technology and exceptional service, which have earned the trust and loyalty of their growing customer base.
Why now?
We think the timing is now excellent for Japanese equities and for our strategy for three key reasons:
- Market positioning: We believe investors have not yet fully recognised the shifting earnings momentum. The majority of investors seem to still be positioned in the value themes – one could say the market is still investing with yesterday’s mentality. We remain focused on quality growth companies; we are convinced that our portfolio companies are likely to experience more frequent positive earnings surprises and above-average earnings growth over the long term.
- Potential for a rerating in valuations: Our quality and growth-tilted portfolio valuations have been reduced in response to the sharp interest rate hiking cycle in the US. However, with the Federal Reserve beginning its rate-cutting cycle in September, this could provide an additional tailwind for our long-duration growth approach from a valuation perspective.
- Strengthening yen: Lastly, the narrowing interest rate differential between Japan and the US is expected to support a strengthening of the yen. This could serve as an additional positive, as companies with strong pricing power are better positioned to raise selling prices in foreign currencies. Furthermore, a stronger yen could enhance returns for foreign investors.
Ernst Glanzmann, Lukas Knüppel and Katsuya Takeuchi manage Japanese Equity strategies at GAM Investments
Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Investors could lose some or all of their investments.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index
The foregoing views contains forward-looking statements relating to the objectives, opportunities, and the future performance of the markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Investors could lose some or all of their investments.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index
The foregoing views contains forward-looking statements relating to the objectives, opportunities, and the future performance of the markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.