Since last summer, our Asset Allocation Committee has been shifting its views in favor of exposure to the economic recovery from the coronavirus crisis. That has regional as well as asset-class and sectoral implications. In general, when risk appetite is high or a new business cycle is gathering steam, the Committee looks increasingly to markets outside the U.S.—the manufacturing centers of Europe and Asia and the commodity producers of the emerging world.
That is true of its latest views, even though, unlike a decade ago, this economic recovery is led by the U.S. rather than China.
The U.S. government’s $1.9 trillion stimulus package will certainly boost domestic growth. At 916,000, Friday’s non-farm payroll data beat estimates by almost 300,000 and was the highest reading in seven months. But when the OECD recently upgraded its global growth forecast for 2021 by 1.4 percentage points, to 5.6%, it noted that a full percentage point of that would come from the U.S. stimulus. One reason is likely to become clearer this week: checks going into the pockets of U.S. consumers are more likely to be spent on imported goods than on still-restricted domestic services.
But where exactly does the Committee think investors will get the most benefit? It has been overweight Japan in its asset allocation views since the middle of 2020, which has informed a key exposure to the TOPIX Index in our multi-asset portfolios. That is one of the important places where we think investors should be looking.
Dollar Exposure
One recent effect of U.S. leadership in the current recovery has been the strength of the dollar. A stronger dollar in 12 months’ time is not our central view, but its recent rally has caught many investors off-guard and we consider it more of a risk now than we did three months ago.
That makes us marginally less favorable toward emerging markets, whose dollar exposure has shown up in relatively poor performance so far this year. Higher inflation, a shift to tighter monetary policy and rising risk premia in response to several large fiscal stimulus packages add to the pressure, which can lead to the kind of systemic issues we see currently in Turkey, for example.
European markets also look less favorable to us than they did a few months ago, as a number of countries struggle with a new wave of coronavirus infections and a spluttering vaccination program, as well as a lack of fiscal firepower relative to what the U.S. has mustered.
Geared to the Recovery
Japan is not insulated from some of these challenges. It is currently enduring its fourth wave of coronavirus infections and has no domestic vaccine production. When the Olympic Games begin in July, they will be a quieter affair than usual, with no overseas spectators.
Against that, we weigh the country’s $3 trillion of fiscal stimulus packages, with still more spending under debate following its recent record-breaking budget for the coming year. We look at how Japan’s exporting manufacturers are geared to the global cyclical recovery—and, unlike many emerging markets, how they would likely benefit from a stronger dollar and weaker yen, as U.S. consumption sucks in imports. We note that, according to FactSet, the TOPIX Index is up more than 10% this year—almost keeping pace with U.S. small caps—while the MSCI Emerging Markets Index has returned less than 3%.
Shareholder Value
Most notably, however, attitudes toward shareholder value among Japan’s corporate management appear to be changing. A growing number of activist events—a defeat for Toshiba at the hands of its largest investor is only the latest to catch attention—has started to make management “more responsive to shareholders’ interests,” as our own Japan small- and mid-cap equity team has put it.
The success that this team has enjoyed over the past 12 months, through engagement with increasingly “capable and open-minded management that is willing to listen to long- term shareholders like us,” is testament to that trend. We hear similar reports from our local private equity experts. Both teams see a lot of opportunities where capital expenditure remains modest and costs can be reduced—and where management has become much more open to new ownership and new ideas.
That potential to unlock pent-up value makes Japan a favorite in the race to bag a medal from the economic recovery, in our view. Global investor capital could be on its way to Japan this year, even if sports fans are not.
