Japan's laggards due a re-rating

7th Jul 2010 14:39

The Japanese economy has suffered with the best of them over the past few years, a situation made worse by a strong local currency and political uncertainty.The country has sworn in five prime ministers in just four years and, more worryingly, nine finance ministers."Politics has been unhelpful," Andrew Rose, manager of the Schroder Japan Growth fund, said today. "Japan's recent history has been characterised by short bursts of outperformance linked to cyclical upturns in the global economy, but that hasn't happened this time."Rose blames the strong yen and fading optimism about the political outlook.The Nikkei has already tumbled around 15% since April as global stock markets fret about the speed of economic recovery.Disappointing data out of China hasn't helped, but Rose reckons this could turn into a positive as it may put a brake on contractionary monetary policy. More of a worry is Europe's sovereign debt crisis. "In a world obsessing about sovereign debt, Japan sits rather uncomfortably," he admits. Outstanding debt is 180% of gross domestic product, more than Greece, although net debt is quite a lot less.But those are problems facing governments the world over. They may even lead to much-needed reform of Japan's tax system.Generous rebates and policy quirks let an unbelievable 71% of Japanese companies and 35% of workers pay no tax. Thankfully, all major political parties are committed to tackling the issue.John MacDougall, manager of Baillie Gifford's Shin Nippon Investment Trust since 2007, thinks there could also be some reduction in corporation tax to encourage investment, and reckons there's scope for an increase in the consumption tax (VAT) from 5%. It's going up to 20% in the UK next year.Watch out for the result of Japan's latest general election on Sunday, but no prizes for predicting a hung result and new coalition.Despite all the risks, MacDougall doesn't think the overall economy needs to be "shooting out the lights" to provide companies with decent profits and high growth."In time the market should come to re-rate these businesses," he says.In an "out of favour and under-researched" sector, MacDougall has built stakes in nursing and home care services firm Message, drug tester EPS and internet fashion retailer Start Today.Even the strengthening yen is less of a worry than in the past. "Companies have adjusted down their breakeven levels and are just about OK at 90 yen to the dollar," says MacDougall.Rose is more concerned that the Japanese currency has been attracting safe haven flows in recent months, but thinks the yen will have to hit 85 to the dollar before the Bank of Japan steps in. It's about 87.3 now compared with 94.5 at the start of May.In the three months to the end of April, BGSN's net asset value (NAV) rose 18% to 164.7p, outpacing a gain in the MSCI Japan Small Cap Index of 14.6%.The discount to NAV narrowed from over 17% at the end of January to less than 11% on 30 April.On the same day, Schroder Japan traded at a 13% discount to net assets of 104.47p a share, which had risen by 15.5% over the three months.