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Magnificent seven sets high hopes for Japan

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Summary

Seven quarters of growth, increased capital spending and the Tokyo Olympics underpin a strong outlook for Japan

2 min read

Tokyo Olympics pure gold for Japanese economy

Japanese manufacturing hit a four-year high this week – just the latest positive development from an economy that is steadily gaining strength.

The news follows Japanese machinery orders reaching their highest level in a decade in November, a sign of increased confidence after seven straight quarters of growth since the first quarter of 2016.

This all bodes well for the country’s equities. And with the Tokyo Olympics in 2020 expected to provide a 1% boost in gross domestic product, the outlook is bright.

Meanwhile, the Bank of Japan (BoJ) agreed at its January meeting to leave its economic forecasts and easy monetary policies unchanged. The bank kept its short-term interest rate at -0.1% and said it expected inflation to reach 1.4% in the year to March 2019 – it is currently at 1%.

At Coutts we have liked Japanese equities for some time and highlight the country as a key area to watch in our 2018 investment outlook Investing through disruption.

Its economy has been beset with problems since the 1990s, but corporate and economic reforms put in place by Prime Minister Shinzo Abe appear to be having the desired effect.

The seven quarters of growth marked Japan’s longest period of expansion since 2005, while last year the Nikkei 225 Index hit a 26-year high, recorded 16 straight days of rises and shot up by 19% between September and November.

Coutts Head of Multi-Asset Investment Monique Wong said: “We expect Shinzo Abe to continue his reform program, while the Bank of Japan will maintain monetary policies that are helpful for companies and the financial markets.

“These factors underpin our view that Japan’s prospects are normalising and that the outlook for Japanese equities is positive. In our view, corporate balance sheets are healthy and equity valuations look attractive compared to other major markets.”

Investing through disruption includes our investment convictions for 2018, five key challenges we think will define the investment landscape and our views on emerging trends such as technology and inequality.

“We expect Shinzo Abe to continue his reform program, while the Bank of Japan will maintain monetary policies that are helpful for companies and the financial markets. ”

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The current rally is being led by the emerging markets, up 8%, and the US with the S&P 500 up 5.7% in January - both in dollar terms. Key factors behind this include a good economic backdrop, strong earnings season and US tax reforms, which will cut US corporation tax to 21% from 35%.

This flying start to the year is even more stunning because it comes as bonds have sold off. 10-year bond yields in the US are about 30 basis points higher. This suggests that, for the moment at least, markets think that higher rates reflect better growth prospects.

With valuations continuing to rise, we could see some profit taking from investors. But as long-term investors we at Coutts are focused on the economic environment, which continues to look healthy, and the growth in corporate earnings.

 

Spring time for US interest rates in March?

The US Federal Reserve (Fed) left interest rates unchanged at its meeting this week but set the stage for a rise in March.

This was not in itself a surprise for markets, but departing chair Janet Yellen struck a more hawkish tone than expected on inflation.

She acknowledged the healthy status of the US economy, said she expected inflation to rise this year and made several references to further increases in the federal funds rate – the rate at which banks lend Fed funds to each other overnight.

A rate rise would potentially benefit the financials sector, which is a key investment theme for our portfolios and funds in both our equity and bond positions.

Generally, US economic growth remains solid and continues to drive positive economic momentum worldwide. It is expanding slowly but steadily, consumer and business confidence is riding high and the jobs market is strong.

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