Nicholas Price, portfolio manager of Fidelity Japan Trust PLC (LON: FJV), discusses why he believes the outlook is bright for Japan in the year ahead. He discusses how the market environment is likely to evolve in 2023 and outlines the key Japan investment opportunities he sees among small and medium-sized companies with maintainable growth prospects.

Key points

• Pent-up demand among both consumers and businesses will continue to underpin growth, and we have started to see a pickup in the number of inbound tourists taking advantage of the weak yen.
• While we continue to find a lot of ideas among mid/small caps, we are also seeing attractive opportunities is in the unlisted sector.
• By working closely with our sustainable investing team and maintaining an active dialogue with investee companies, we aim to continually improve the sustainability of their businesses, which should also enhance their performance as investments.

With the global economic outlook darkening, Japan is an outlier – showing a degree of resilience as Covid-19 restrictions ease and the economy finally reopens. Unlike many other countries, the economic policies of the Japanese government and central bank are a positive mix of fiscal expansion and monetary easing.

According to global forecasts by the International Monetary Fund (IMF), Japan’s economy will be one of the few to see growth accelerate this year and maintain nearly the same pace next year. After keeping its borders closed to most travellers throughout the pandemic, Japan has begun reopening. Pent-up demand among both consumers and businesses will continue to underpin growth, and we have started to see a pickup in the number of inbound tourists taking advantage of the weak yen.

Finally, valuations are close to the Global Financial Crisis (GFC) trough and the resilience of corporate balance sheets in Japan means that its exposure to the rising cost of debt globally is limited and buybacks and dividends are set for record highs.

What could surprise markets in 2023?

Inflation surprises have driven market expectations for the pace of Fed rate hikes. As economic activity weakens, however, bond yields are likely to be restrained by lower levels of growth. If the view that long-term rates have peaked gains traction, this would help to put a floor under equity markets. It would also support a bottoming out in growth stocks, and I would expect some of the names that performed poorly in 2022 to come back quite strongly.

There is also the potential for beaten-up technology stocks to start performing again, especially as earnings disappointments are coming out as we approach the trough of the cycle. Meanwhile, Bank of Japan Governor Haruhiko Kuroda’s term will end in the spring and speculation over the future direction of monetary policy in Japan is set to intensify. It’s not yet clear who will succeed him, but it remains to be seen how much longer the Bank of Japan can continue with its existing policy.

Positioning for what lies ahead in 2023

While we continue to find a lot of ideas among mid/small caps, we are also seeing attractive opportunities is in the unlisted sector. New listings (both in Japan and globally) are coming under pressure amid heightened geopolitical and inflationary risks, but new growth companies are still coming through, which will create future opportunities in the pre-initial public offering (IPO) market.

While Japan has always been successful in automobiles and electronics, the information revolution is throwing up new opportunities in areas such as software as a service (SaaS). We are also seeing new business opportunities emerge in response to major challenges facing the world, primarily climate change and decarbonisation. For example, one of our pre-IPO companies, fintech innovator Moneytree, recently announced a tie-up with Cogo of New Zealand to provide carbon emissions analysis for Japanese financial institutions.

As Japan aims to reduce greenhouse gas emissions to net zero by 2050, there is accelerating demand for such carbon footprint management solutions. In terms of risks, the weak yen has been driving an earnings upgrade cycle though the sustainability is uncertain and a severe slowdown in global growth would have negative implications for exporters/cyclical elements of the market. Looking ahead, we are focusing on domestic reopening names and consistent growers. We are also starting to see some emerging opportunities in China-related names and among oversold cyclicals that have already priced in a sharp decline in the US PMI.

Fidelity Japan Trust PLC (LON:FJV) aims to be the key investment of choice for those seeking Japanese companies exposure. The Trust has a ‘growth at reasonable price’ (GARP) investment style and approach – which involves identifying companies whose growth prospects are being under-appreciated or are not fully recognised by other investors.