UBP House View - December 2023

Key takeaways

Editorial

2023 will undoubtedly be seen as a year full of surprises.

Despite all the negative forecasts after 2022, which was a bleak year, risk assets have delivered good-quality returns across most asset classes.

This good performance is, of course, reflected in US and Japanese equities, but also in certain bond segments, with high-yield bonds having risen nearly 9% since the beginning of the year. Of course, dispersion within asset classes is the order of the day, but it shows that cash was not the only investment solution to obtain largely positive returns in 2023. These comments also apply to diversified management, as balanced portfolios provide highly satisfactory performances.

Excessive caution would therefore have been rather penalising at this stage. It would also have failed to recover the lion’s share of the losses recorded in 2022. The good news is that markets now offer a wide range of solutions that will need to be implemented intelligently and in an agile way in 2024. This situation leaves us confident about the coming months, despite the low visibility on macroeconomic data, which is expected to improve in the first part of the year.

Strategy

Japan: Realising benefits of a decade of restructuring and reform

Global equities (ex US) are trading near valuations seen during the 2008/9 global financial crisis, the 2011 eurozone crisis, and the 2020 global pandemic. Some of this can be attributed to the structural economic and geopolitical challenges being faced by Europe and China where challenges remain.

However, while Europe and China are in the relatively early stages of their respective economic restructurings, the benefits of Japan’s “Three Arrows” restructuring and reforms begun nearly a decade ago are now being realised.

As a result, over the past decade, Japan as an equity market has been transformed from a liquidity-driven one powered by expansion in valuations and subsequent collapses, to one now driven almost exclusively by corporate earnings growth.

Indeed, the MSCI Japan has delivered earnings growth of 10.5% annually since 2012, lagging modestly behind the impressive 11.3% per annum delivered by the US’s tech-heavy Nasdaq-100 over the same period.

Japan equities: multifaceted earnings drivers

Though many will cite a weak yen as the key driver for Japan equities’ performances, in fact, it has been widening margins and the deleveraging of balance sheets that have accounted for nearly 77% of corporate profit growth over the past decade. The weak yen, we estimate, has accounted for 6–7% of corporate profit growth.

Looking ahead, with corporate margins near levels not seen the 1960s/early 1970s, further margin expansion may be overly optimistic. However, these wide margins should now generate consistent cash flow to allow the deleveraged balance sheets of Japan’s corporate sector to focus on dividends and expanding buybacks to drive shareholder returns.

Admittedly, Japan equities have delivered an impressive 29.6% return in 2023, with earnings growing by nearly 16% and valuations expanding by nearly 9% through end-November. Despite this, performance valuations sit near 10-year averages, meaning investors can lean on non-cyclical earnings, dividend, and buyback drivers to underpin total returns looking ahead.

An end to Japan’s lost decades allows for earnings-growth-focused opportunities in Japan.

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