The dramatic upwards move in the Japanese equity market since the autumn has plenty further to go, according to Jonathan Ruffer, the founder of the private client fund management group Ruffer LLP, one of the professionals whose latest thinking I (and many others) like to follow closely. Ruffer as a firm has held an overweight position in Japan for quite a long time, and now stands ready to be vindicated if Japan’s new reflation policy takes hold, as the markets now seem to be assuming. Writing in his latest quarterly review, he comments as follows:
We hold roughly half of portfolios in equities, in the UK, Europe, US and Asia, but the largest geographic position is in Japan. This market was broadly flat when we last wrote to you, although we had made good money in financial and property stocks. In the last quarter these and other holdings surged further, providing a strong finish to a dull year. The rationale in Japan remains intact; it is the warrant on world economic growth, and so more of the same in terms of monetary stimulus should favour Japan without the rest of the world’s downside. The stability of Japan, its lack of overcapacity, and the absence of financial or labour fragilities, give some protection, and afford it the ability to generate a self-sustaining economic recovery. The low expectations built into the possibility of a Japanese economic recovery provide the opportunity for further sharp market rises. The major obstacle to a more bullish backcloth has disappeared with the appointment of Abe as Prime Minister, and the forthcoming retirement of Shirikawa as Governor of the Bank of Japan. In this new world, the investment danger for foreigners is a weak yen (we have been fully hedged), but this is a benefit to the equity market.
Japan is not a one-way bet – the new administration has upset China, where exports are down 8% since relations deteriorated. The last two quarterly GDP figures were awful, a much-feared consumption tax is due to impact in the middle of 2014, and taxes on personal expenditure have often been the prelude to recessions in Japan. Nevertheless we sense that the consensus is changing, and there is an inflection point: a realisation that being a rich country does not ensure that this will be a permanent feature – and that they must fight to regain the initiative in wealth-making. The popular image of their society from the outside is of conservative timidity; anyone who knows its people, from Admiral Rozhestvensky in 1905 onwards, will not fall into that mistake. When Japan reaches out in a new direction, hold on to your hats!
Looking ahead, Ruffer also remains concerned about the potential for inflation, and therefore retains his above average holdings in index-linked gilts, despite their fancy prices (negative yields in some cases);
Most people can see the insurance value of index-linked stocks, but regard them as completely wrongly-priced. We are comfortable to hold this asset class in the conviction that this will protect us in another apocalyptic move, brought about when the markets no longer allow governments to act as they presently do. It is the most important element by far in the portfolios, and yet it is not a big bet. We do not need this frightening outcome for our portfolios to prosper – we have the rest of the assets to keep things going in the sunshine.
Sensible thinking, as always, I suspect. However you expect the debt crisis to play out, some measure of inflation is going to be part of the answer. And even the Japanese, after two decades of deflation, now have little choice but to embrace the same solution. A 2% inflation target (what the new Abe government in Tokyo is expected to introduce) may be humdrum by US and UK standards, but it is potentially revolutionary in Japan. Hedged Japanese equity exposure therefore looks an attractive option.