Insights

Japan equity was the best-performing asset class in 2023, but despite the Nikkei reaching all-time highs in 2024, Japan also recently experienced economic contraction. Against that backdrop, Japan Equity Investment Director Junichi Takayama offers five reasons why Japan’s economic resurgence still has ample runway.

We visited Vietnam in February and found that business and economic prospects have turned around completely for the better from a year ago. Interest rates have normalised, and mortgage terms are the most favourable that we have ever seen in Vietnam.

This month we focus on the prospect of Japanese stocks sustaining their upward trajectory after reaching record highs; we also assess how the country’s Q4 GDP contraction sharpens the focus on consumption and wages in 2024.

One of Japan’s more recent economic releases made us sit up and take notice. Within the very resilient Q4 capital expenditure figures released this week was one important reinforcing indicator of Japan’s structural recovery, or in the Bank of Japan’s language, its “virtuous circle” of reflation. One near-term positive development for Japan is the very real possibility that the “technical recession” in Japan Q4 GDP (down 0.4% quarter-on-quarter) could be, thanks to unexpectedly strong Q4 capex, revised away.

This is the “swan song” of this report, which comes at an appropriate time because it was always meant to prove to readers that corporate governance, and the overall case for investing in Japanese equities, was sound. Now that the market’s performance and global enthusiasm for Japan has swelled, there is less need for the report, although it is useful to note the continuance of its impressive trend.

We explain how reflationary dynamics underpin the foundations of Japan’s incipient structural recovery and illustrate why we believe the country’s equity comeback should not be written off as another flash-in-the-pan cyclical upturn headed for an eventual return to deflationary dynamics.

The seemingly impossible soft landing on the back of one of the most aggressive monetary tightening cycles in history is looking not just possible, but increasingly probable. US data is coming in stronger and global demand is generally steady with increasing channels of potential upside.

Our economic system is based on a model of take, make and waste that consistently over-utilises and fails to replenish Earth’s valuable, but dwindling resources. The need to transform how we interact with nature creates a major opportunity for the green bond universe. So far, issuers have successfully embraced funding the transition toward carbon neutrality, but far fewer are looking at regenerative biodiversity projects or initiatives that seek to protect our ecosystems from loss.

Our Future Quality investment philosophy revolves around identifying companies that have pricing power, possess management teams that invest will appropriately, boast strong balance sheets and offer opportunities that are not yet priced in by the market. This approach will remain constant in 2024 although we are also acutely aware of the significant impact energy security will have on global decarbonisation efforts.

The Indian market remains attractive. It has the highest earnings growth in the Asian region, valuations that are in the middle of its historic range and an economy that is growing strongly with inflation under control.

We expect an anticipated decrease in developed market bond yields, coupled with enhanced foreign inflows, to bolster demand for Asian bonds. We see Asia credit remaining well supported with subdued net new supply as issuers continue to access cheaper onshore funding.

The emergence of AI has dramatically shifted the future pathway for the technology sector, and our research has found that this emerging structural trend chimes with our Future Quality principles.

While fixed income issuance has become a standard mechanism for governments and companies to raise finance, it often lacks a defined purpose. However, the growing trend of responsible investing is changing that. The need to tackle our planet’s many climate, environmental and societal challenges is reuniting fixed income with its sense of purpose.

This month we discuss how emerging growth narratives such as semiconductors may come into focus in 2024; we also assess the slightly hawkish turn the BOJ took at its January policy meeting.

Last year, global investors turned their attention firmly towards Japan as a way of increasing their Asia exposure while avoiding perceived geopolitical and regulatory risks linked to China, and amid the high inflation environment dominating western economies. But this year, Japan’s success is more based on its own merits.

The US economy continues to look robust, so we have stayed constructive on growth assets and short maturity global credit where yields are attractive. We still believe that the path to 2% inflation in the US is relatively unclear. If anything, our conviction on this point has increased because easier financial conditions may ultimately pave the way for the return of sticky inflation.

The peaking of interest rates and potentially the US dollar could be a boon for broader markets—particularly those more sensitive to liquidity, countries with more room to ease rates and areas where positive fundamental changes have been overlooked. China’s economy is undergoing a major transition into one that promotes advanced manufacturing, technology, self-sufficiency and higher-end overseas growth. These are areas of our focus.

We expect macro and corporate credit fundamentals across Asia ex-China to stay resilient due to fiscal buffers although slower economic growth seems to loom over the horizon.

This month we discuss why the equity market is relatively unaffected by the political scandal shaking Japan’s ruling party; we also assess how 2024 could become an inflection point in the country’s “savings to investments” drive.

Although we believe that the prospects for the economy remain mostly unchanged, the outlook is softer at the margins, perhaps reflecting the tightening of financial conditions seen during the recent months. Over the past month, however, financial conditions have eased considerably on the assumption of impending rate cuts.

Given the volume of quality defensive companies with relatively high dividend yields, higher for longer interest rates are a significant headwind for New Zealand’s equity markets. Alongside these, the country’s globally-focused export companies will be looking for the global growth story to play out positively, but for the meantime will at least be enjoying a relatively weak New Zealand dollar.

Japan may not be known for quick, sweeping reforms. However, developments in the country’s corporate governance over the last 10 years suggest that once changes are set in motion, they can have a deep and lasting impact, raising the value of its companies and creating investment opportunities along the way.

We expect poor 1Q24 returns for MSCI World after the 4Q23 surge, but a more positive trend for the rest of 2024. Regionally, we much prefer Japan in the year ahead. Our view on global bonds for USD-based investors is that they are preferred during much of the 1H, but only marginally attractive in the 2H.

We expect sentiment toward Asia’s bond markets to turn increasingly positive in 2024. We also expect macro and corporate credit fundamentals across Asia ex-China to stay resilient on the back of fiscal buffers, although slower economic growth appears to loom over the horizon.

Despite short-term negatives, we believe that China continues to offer ample long-term growth opportunities as the country pivots towards advanced manufacturing and technology. Elsewhere, some of the best growth stories globally could be found in India and Indonesia, while Taiwan and South Korea are expected to continue benefitting from a modest upcycle as the semiconductor industry recovers.

We discuss how a bullish year for Japan equities has brought what was previously out of sight into view and analyse focal points for the market as we head into 2024; we also assess how focusing on efficiency and growth could be the way forward for Japan given its projected drop in the GDP rankings.

Our investment themes for 2024 focus on key features of a world in transition. They include higher-for-longer rates, production shortages in natural resources and the search for new sources of productivity. Transitions are never easy, and features of the old world accustomed to low rates may not make it. We believe that some of these old-world features could pose systemic risks as “creative destruction” does not always run smoothly.

We are heading into a changing world, where the more recent past can no longer be relied on to guide our path forward. But we are not blindfolded. There are tools we can use to provide a greater degree of certainty. Our Future Quality approach is designed to help us identify franchises that are set to endure.

We present our 2024 outlook for sustainable fixed income, core markets and credit markets.

We expect 2024 to be a year of domestic consolidation and long-term reform measures, where markets are driven more by Japan-specific events than by global factors. After decades of deflation, we see Japan as finally breaking out of this cycle in 2024, as it enters a virtuous cycle of price increases and wage hikes.

Considering that major tech companies are profitable, cash rich and cannot afford to lose out in the highly competitive AI race, spending on high-end computing and neural networks looks set to continue in 2024. This will likely create a lasting boon to many component suppliers (the so-called picks and shovels of AI) across Asia.

We believe that our “New Singapore” narrative focusing on sectors and companies that represent the future of the city-state will remain relevant in 2024. Energy transition has risen to prominence within the New Singapore narrative in addition to data, technology, healthcare, logistics, tourism and food solutions.

Much like this report in 2023, global conditions will remain unique and defy a confident overall summary; thus, here are ten predictions on some particularly noteworthy factors.

We expect 2024 to be a year of higher returns and lower volatility for Asian local government bonds as US Treasury yields are seen stabilising. We also see Asian currencies firming against the dollar in 2024 as the Federal Reserve’s rate hike cycle comes to an end.

We believe ASEAN will offer good pockets of growth and quality opportunities, as well as earnings resilience and protection amid some of the prevailing global macro headwinds.

For those willing to brave immediate challenges, we believe China will continue to offer long-term opportunities as the country has been working to become technologically self-sufficient and develop high-end technologies on its own in a more challenging regulatory environment.

We expect fundamentals and technical backdrop for Asian credit to remain supportive in 2024. However, valuation is a challenge with current Asian high-grade spreads near historical lows. The myriad cyclical and structural factors driving the major sub-sectors within Asian high-yield credit makes it is difficult to call the overall spread direction in 2024, although the current spread level remains wide and offers room for compression over the medium term.

The just-released 3Q CY23 data on Japan’s aggregate corporate profits was a bit mixed, but the overall corporate recurring pre-tax profit margin surged to a record high on a four-quarter average. The non-financial service sector rose to another record high, but the manufacturing sector fell further from its record high.

We have held on to our view that the “higher for longer” narrative is not necessarily bad for equities, as robust earnings are supported by a US economy that continues to grow at above-trend rates. However, we are also sympathetic to the de-rating process where earnings look simply less attractive compared to higher rates across the yield curve.

We expect macro and corporate credit fundamentals across Asia ex-China to stay resilient with fiscal buffers, although slower economic growth appears to loom over the horizon.

The last few quarters have been a good reminder that we are in a changing world. As a result, we need to focus always on investing in enduring franchises and we would suggest that our Future Quality approach is soundly placed in that regard. We also need to approach monetary policy with an open mind—sometime soon the central banks could change the game again. In surfing parlance, be ready with your trusted board and make the most of the conditions.

Recently many fixed income investors have experienced steep price declines in their bond portfolios. We have argued that it is not only duration that explains the interest risk of a portfolio, but that convexity needs to be accounted for as well. In this paper we point out that credit risk measures also have to be adjusted in an environment of declining bond prices.

We analyse the Bank of Japan’s decision to further tweak its yield curve control scheme amid the latest developments hinting at sustained wage growth; we also assess why an acute labour shortage could be a golden opportunity for Japan Inc. to change structurally.

While the risk-off environment stretched into another month, we are still finding plenty of positives in Asia. India’s macro remains favourable; Chinese equity markets are near the cheapest in 20 years; and the semiconductor industry is showing signs of a bottoming. With the US potentially having reached peak interest rates, this could be a welcome backdrop for Asian markets going forward.

We explore the opportunities and risks emanating from China’s near-zero inflation and India’s above-average consumer prices.

Defying seemingly broad sentiment that a slowdown is coming, the US economy continues to chug along, and bond yields are continuing to wake up to the monetary reality that long-term rates need to be repriced accordingly. The adjustment has been aggressive and fast. Still, there is a natural limit to these types of moves.

Modern alpha relies on multiple sources and is therefore more stable and recurring than the traditional “big bets”. For most investors, the main source of alpha is fundamental research. But to add stability it is plausible to combine fundamental research with quantitative strategies as an additional alpha source.

Amid the current rise in oil prices, global central banks have become more vigilant against inflation, becoming increasingly wary of risks occasioned by a potentially premature end to their rate hiking cycles. Consequently, we deem it prudent to be more cautious on duration. We therefore have a largely neutral view on duration for most countries in the region.

We have long been enthusiastic about the ASEAN share markets, and the region continues to offer appealing prospects. While the fundamental drivers behind ASEAN’s growth and opportunities are not entirely new, in our view the trends remain irrepressible. We discuss two key pillars—industrialisation and consumerisation—that are expected to help cement ASEAN’s place in the minds of investors.

We believe that a long-term revival looms for Japan. Deflationary pressures are dissipating amid rising wages. The financial markets are headed for a resurgence, supported by robust stocks—which could benefit further from a re-allocation of the country’s vast household savings—and BOJ monetary policy headed towards normalisation after decades of unorthodox easing.