Candriam holds a neutral stance on Japanese equities. We think a weaker currency or the resumption of the reflation trade is required for more conviction.
We learnt on June 16th that ample liquidity injections from the Bank of Japan (BoJ) will continue at an uninterrupted pace. Unlike the Federal Reserve or the ECB, there is no end in sight for BoJ balance-sheet expansion. Ultimately, this should weaken the currency. This is important, as Japan’s relative equity performance remains highly correlated (-70%) to its currency. Seen as a safe-haven currency, the JPY has not, so far in 2017, been supportive for corporate Japan.
Positioning and flows show an awakening of interest in the region. International investors, whose actions are well correlated with Japanese equity performances, think that Japanese equities are cheap. Accordingly, the current quarter shows the strongest net non-resident flows into Japanese equities since 2015, supporting the recent outperformance.
Favourable conditions support the Japanese economy. A supportive policy mix, a tight labour market, improving profit margins and corporate pricing power are currently at work. In addition, global growth is now a more significant determinant of Japan's corporate sales and profits than the country's GDP growth, as overseas sales account for 58% of total revenue.
The next step, an overweighting of Japanese equities, would make sense if global growth continues its improvement, as this could lead to a resumption of the reflation trade, implying a stronger USD and rising bond yields.