A TGEG perspective on Japanese equities amid volatility

A historic selloff in Japan

On August 5, 2024, the worst selloff since the Black Monday stock market crash in 1987 hit Japanese equities. The selloff was driven mainly by macro and systematic trades amid rising concerns of a US recession, as US manufacturing activities in July contracted the most in eight months, according to the Institute for Supply Management (ISM) data.

A weak US jobs report for July, as well as broader reductions in global risk asset positions—including the unwinding of the Japanese yen carry trade—also pressured sentiment.

Dislocation from fundamentals

The extreme market reactions seem dislocated from fundamentals, in our view. Unless one thinks the US economy is in for a hard landing, the level of the selloff in Japanese equities appears unjustified.

We expect market volatility to persist in the short run amid the ongoing debate surrounding the US outlook and uncertainties driven by the unwinding of the yen carry trade. However, our base-case view is still a soft landing for the US economy. Against this backdrop, Japanese equities should continue to deliver long-term value, especially for fundamental stock pickers.

Structural catalysts still in play; an active approach is key

In our view, the fundamental picture for Japanese equities remains unchanged, and Japan’s structural return on equity (ROE) improvement story is intact. Japan’s economy is normalizing after three decades of deflation, and corporate reforms have gone mainstream. Importantly, Japanese equity valuations are undemanding, with a 25% discount versus the MSCI World Index¹ following the August 5 selloff.

These unique opportunities are under-represented at the stock index level. We believe they are best captured through active management. For example, each company is at a different stage of its corporate reform journey. We think global investors seeking to benefit from the structural shifts taking root in Japan may want to consider an active manager with a focus on stock-picking across all market caps and types of value situations.

Look through volatility; focus on intrinsic worth

As we untangle the current bout of market uncertainties, it is useful to keep in mind something Benjamin Graham, the father of value investing, once said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

TGEG believes the discovery of a company’s true weight—its intrinsic worth—is the key to unlock long-term investment success. That remains true of our approach in Japan. We are ready to look through the current volatility and explore the full spectrum of mispricing opportunities, leveraging on Franklin Templeton’s value mindset and business owner approach for stock picking.

Endnotes

The TOPIX is used to represent Japanese equities. It is a capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange. The MSCI World Index captures large- and mid-cap representation across 23 developed market countries. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator of future results.

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