Japan stands to benefit from Trump policies
Other than the US itself, we believe that the country that will benefit most from the policies to be implemented by the Trump Administration will be Japan.
The three pillars of President Trump's policies are tax reform, deregulation and infrastructure spending. We think that these measures are highly likely to be implemented - in particular the tax reform - given that there will be an absence of political gridlock in Washington.
These policies are expected to boost US GDP growth over the next few years. Given Japan's dependence on the US (20% of total exports, valued at JPY 15 trillion in 2015) and outbound direct investment into the US (USD 419 billion as of end 2015), it stands to benefit a great deal from these policies' implementation.
Changing policy mix in US to drive Yen lower
Looking at US monetary policy, the Federal Reserve has been in a rate hike cycle since December 2015, implying that the US economy is recovering steadily.
The job market is also tightening, as evidenced by the unemployment rate now at 4.7% in February 2017, which exceeded economists' expectations.
Fiscal stimulus under President Trump in the current environment is likely to cause interest rates to rise, resulting in the US dollar continuing to strengthen against all other major currencies.
If investors make decisions based on fundamentals (i.e. if the currency market is driven by interest rate differentials), we think that the currency that is likely to see its value drop the most is the Japanese Yen.
This is because the differential between US and Japan interest rates will widen as the US rate rises, and that of Japan remains anchored at a low level due to the Bank of Japan (BOJ)'s new policy framework. Under this framework, introduced in September 2016, the central bank commits itself to keeping the 10-year JGB yield around 0% through its "yield curve control" policy.
As an excessively strong US dollar may dampen US exporter earnings, ‘one-sided' strength in the greenback could trigger a political intervention. Having said that, the US already has a large trade deficit, and a stronger US dollar will result in lower import prices, boosting disposable income. This will likely have a positive impact on US GDP growth.
Outlook for Japan equities
Looking at the corporate earnings trend for Japan, revenues and profits fell year-on-year in the first half of 2016, with the second half being much stronger driven by profit growth in the manufacturing sector.
However, despite the stronger Yen, net profit margin is on the rise and is poised to surpass market expectations by reaching an all-time high this fiscal year (ending March 2017), thanks to companies' aggressive cost-cutting efforts.
Valuation-wise, the price-to-earnings (P/E) multiple for the broad market TOPIX is attractive. In fact, multiples have been driven down by foreign investors, as a strengthening of the Yen triggered skepticism of the government's ‘Abenomics' economic policies.
We believe that further improvement in corporate governance at Japanese companies will also translate into higher stock prices. Among the significant successes of Abenomics has been the implementation of Japan's Stewardship Code in 2014, and Japan's Corporate Governance Code in 2015. A few years following the introduction of the codes, we are seeing a significantly positive change in the way corporate managers are engaging with shareholders.
We believe that, in an increasingly uncertain world, Japan's less uncertain market will provide a compelling opportunity for serious investors.
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