2023-06-08 11:01:20 ET
Summary
- We fled to where credit was flush when we saw what was happening in the West to sponsor activity and the credit crunch concerns.
- Japan is the only market that we were sure was not going to hike rates, even though speculation that they would have been persisting since before Christmas.
- With the Yen already having taken its hit in 2022, the current 2023 run shows a record of pure profit for Western investors.
- It also reminds us that equity markets love liquidity. FLJP, which captures large and mid-cap exposures in Japan, massively outperformed other national ETFs, demonstrating that.
- We also think that moves by the TSE to promote corporate governance could sustain a brighter Japan market outlook, where dividend yields can finally catch up to the US.
The Franklin FTSE Japan ETF ( FLJP ) shows one thing: equities love liquidity, and liquidity, at least lately, is found in Japan. While US markets had to be wrenched by AI and a pretty narrow tech rally. Japanese markets have been monster performers YTD, ahead of any other developed market to our knowledge. We were overweight Japan and we think the rally could extend. Japan remains a developed market, and momentum can actually be the factor that's needed for a sustained rally. Moreover, there are corporate governance shifts that could bring up dividend yields, which are generally pretty low in Japan and could sustain more institutional investment were they to go up as planned by the TSE. However, we note that the 15x PE is nearing historical, long-term levels for similarly developed indices like the SPY. The upside would come from foreigners and Japanese investors seeing a vigorous prospect in Japanese markets.
FLJP Breakdown
The FLJP breakdown is a pretty standard view on a value-weighted Japan portfolio. The sector exposures are focused on industrials and consumer discretionary, where the latter is exposed primarily to automotive.
Sector Allocations (Franklin Templeton)
Top exposures are stocks like Toyota Motors ( TM ) and Sony ( SONY ), other major exposures are some of the financials.
Expense ratios are low at around 0.09%, much lower than iShares equivalents like iShares MSCI Japan ETF ( EWJ ) at 0.5%, and the PE ratio of the ETF is around 15.5x, telling you broadly what the PE ratio is of Japanese indices. Still lower than 21x PE for the iShares Core S&P 500 ETF ( IVV ).
Comments
The performance of Japanese markets has been phenomenal, and we have been seeing some peaking now thanks to profit taking . Foreigners ( including Warren Buffett ) are piling in, it's the Japanese that are taking profits. They have had enough experience with pretty limited rallies. Japan doesn't see the sort of speculative and hype-based market dynamics that grip tech-lead US markets.
In comparison, the US market is up around 10%.
While there is some peak selling, there are trends that together could help Japanese markets come more in line with the more parsed and mined US markets. Naturally, there are demographic concerns, but they are extremely easy to model and are likely going to stay priced in. There are the remaining upsides that firstly some momentum in Japanese markets could get more risk averse institutions back into Japan from abroad. While buying momentum is not a sound strategy for quasi indexers, they are not going to ever stick their necks out into any questionable market so momentum is needed to cover large blocks of capital coming into Japan. There is also the local investor base, which is overinvested in government bonds. Such weak Japanese yields should force younger cohorts who have never seen a bubble environment into equity markets. Japan also has tax protected savings accounts not too unlike Roth IRAs that should incentivise this. Japanese markets also have a healthy amount of IPOs, where IPO activity has actually stayed quite healthy, compared to the rest of the world (especially the US) where it has basically ceased.
Finally, there are the governance tailwinds that could really matter for putting Japanese companies more firmly in institutional crosshairs. The TSE is requiring higher metrics for companies listed in the less marginal levels of the exchange. In particular, things like capital payout are important for the TSE, like stable dividends and utilising specials . Another things is available float. This is important because there is a lot of cross-holding among the largest Japanese companies. More free float means more space for institutions.
High yields could bring in institutional money. For industrial and consumer discretionary exposures, Japanese payout ratios are way too low. In addition to a more mixed base of holders, price discovery could continue to drive pockets of value that still exist in bloated cash balances, cross-held companies and other dynamics in the Japanese market that limit price growth.
However, we always lean towards holding single stocks, especially in Japan where you don't have to look that far to find mispriced ones.
For further details see:
FLJP: Equities Love Liquidity