Japan: Dovish Policy, Weak Yen Meet Undemanding Valuation
- Japanese equities held up relatively well in the first four months of 2022 in local terms as the sharp fall in the yen has benefited cyclical, export-oriented and often global Japanese companies, enhancing their competitiveness or directly improving earnings in local terms.
- Extremely low inflation has allowed the Bank of Japan to remain dovish, keeping yields low and thus supporting already undemanding equity valuations. Similarly, fiscal easing offers a cushion for the real economy against elevated commodity prices.
In the first four months of 2022, Japanese equities, in JPY terms, have offered a degree of protection against the deteriorating geopolitical and economic backdrop, falling 4.2%1 compared with a 13% fall in the MSCI World (in USD terms).
There are several reasons behind this relatively strong performance in local terms. The root cause is inflation – or, to be more precise, the lack of it. While consumer prices are increasing by high single digit numbers across the developed world, inflation in Japan (measured by CPI) is expected to average about 2% in 2022, according to economists at State Street Global Advisors.2
Low consumer inflation allows the Bank of Japan to remain dovish, thus diverging from the hawkish monetary pivot observed elsewhere. As a consequence, yields across the curve remain extremely low with 10-year Japan government bonds yielding 0.22%,3 which is far less than US Treasuries, which offer approximately 3%, and 10-year German bunds, which yield 0.94%.
Low yields support already-undemanding valuations, with the 12-month forward P/E at 12.4x4 translating to a generous 8.1% earnings yield. Fiscal policy is also supportive with a record JPY 107.6 trillion ($936 billion)5 state budget approved earlier this year with additional spending planned to provide economic relief to society against raising commodity prices.
The divergence of the monetary policy approach of the Bank of Japan, especially when compared to the US Federal Reserve (Fed), has led to sharp JPY depreciation. USD/JPY exceeded 130 in April, a level unseen in two decades. Needless to say, investors who decided to hedge their JPY exposures were far better off as, in USD terms, MSCI Japan has lost 14.8% year to date.
Interestingly, when the Fed hiked rates (as expected) by 50 basis points on 4 May, JPY remained stable, which may suggest that half point US rate increases are largely priced in the FX rate. However, investors who see this as a short pause rather than an end to the JPY weakening trend may prefer to use currency-hedged exposure.
USD/JPY Exchange Rate
Currency is a double-edged sword. But we believe that, for MSCI Japan, weak JPY can provide far more good than bad as 47% of revenue (market cap weighted) generated by companies within the index comes from outside of Japan. Although elevated commodity prices weigh, to some extent, on input costs, weak currency improves the competitiveness of exporters. Companies using USD-denominated contracts are particularly well positioned, benefitting already in the top-line while global businesses generating part of their revenue and bearing costs in foreign currencies benefit from repatriation of earnings when translated to JPY.
MSCI Japan Revenue Split by Region*
Against the weak yen, low yields, undemanding valuation and the global economy approaching normal activity post COVID, cyclical and export-reliant MSCI Japan appears to be particularly well positioned.
How to Play the Theme
Investors looking to access Japan equities can do so with SPDR ETFs. To learn more about these ETFS, and to view performance histories, please click on the links below to visit their fund pages.