A podium finish for investing in Japan

Ahmed Farooq, CIMA®, CFP

Ahmed Farooq, CIMA®, CFP
Vice President - ETF Business Development at Franklin Templeton Canada

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The 2020 Tokyo Olympic Games is scheduled to begin July 23, a full year after its original start date. If the event will go ahead is still subject to change, of course, as is the case with most things since COVID-19 became a dominant force in our lives.

Since the historically sharp drawdown at the outset of the pandemic, equities markets have performed well, and in Japan’s case, the Nikkei Index is currently at highs not seen since the early ‘90s.

In its most recent update, the IMF forecasted that Japan would register 3.3% GDP growth this year and 2.5% in 2022, having contracted by 4.8% last year. Japan has had significantly less COVID deaths than many other major economies, particularly the U.S. and the U.K., but its vaccine roll-out has been much slower and coronavirus infections are rising sharply presently.

How effective vaccines are outside of Japan is also crucial for the country’s economic health, given the importance of its export industry. Should China and the U.S. record strong growth this year as predicted, Japan’s auto sector will likely reap the benefits as a brighter economic picture brings increased demand for vehicles from the likes of Mitsubishi, Honda and Toyota.

According to a recent report by Thomson Reuters, publicly traded companies in Japan are predicted to report earnings growth of ~40% in 2021 compared to ~23% for the S&P 500. In addition, the Nikkei 225 has a lower price-to-earnings (P/E) ratio than the S&P 500, making Japanese stocks even more attractive as an investment.

This view is supported by Ed Perks and Gene Podkaminer of Franklin Templeton Investment Solutions, who explained in their March 2021 Paper, Some Like it Hot: “Japan appears well-placed to benefit from a cyclical economic rebound, policy continuity and a relatively muted COVID-19 impact. Although earnings per share have been weakening relative to peers, equity valuations, particularly on a price-to-book-value basis, remain attractive relative to other markets, in our view. We have extended a more constructive view on this market.”[1]

Of course, there are some significant areas of concern for Japan aside from the coronavirus, principally the country’s aging population and a public dept-to-GDP ratio (280% in FY2020) that is the highest in the world. In response to these structural challenges, the new government of prime minister Yoshihide Suga has indicated that investment in the digital economy and green energy will be a priority to safeguard Japan’s position as a global economic powerhouse.

In the near term, the signs are mostly positive, as the Bank of Japan’s March update showed that business confidence had improved to pre-pandemic levels in the first quarter of 2021, while the Purchasing Managers' Index for the manufacturing sector rose to 52.7 in March, its highest level since October 2018.

For those interested in adding Japanese exposure to their portfolio, but are unsure about what companies present the best opportunities, Franklin FTSE Japan ETF (FLJA)  is a low-cost (9 basis points) solution to access large- and mid-sized companies on the FTSE Japan Index. With a one-year return of 22.49%,[2] the ETF benefited from the recovery in Japan’s economy in the second half of 2020 and is positioned to take advantage of any further boost from the global economy reopening.

The importance of portfolio diversification remains through up and down markets; bearing this in mind, investing in the Land of the Rising Sun should help with the geographical mix of your assets, as well presenting access to some of the globe’s most well-established and profitable companies.

 

1.   https://www.franklintempleton.com/investor/article?contentPath=html/ftthinks/common/allocation-views/some-like-it-hot.html

2.   As of February 28, 2021

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What Are the Risks?

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

Ahmed Farooq’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.