29 May 2013

Portfolio Adjustment – Japanese Equities and Global REITs

Japanese Equities

Despite a significant run up in the Nikkei225, the Japanese stock market continues to offer ample opportunities for investors. Abenomics is gaining traction among businesses and consumers in Japan1. The shift in corporate and consumer psychology can be seen as a structural change in the Japanese economy, where cash hoarding comes to an end and inflation expectations start to rise. This will result in an increase in consumption and eventually investment in Japan.

Having been accustomed to a high yen over the past five years, Japanese businesses have been forced to reduce costs to survive. News of mergers by large Japanese corporations were rampant before Premier Abe won the elections. Now, that the yen is 20% lower than the US dollar, and 25% lower than the euro, the benefits are starting to accrue to the bottom line of Japanese corporations.

The first leg of the Japanese rally has been driven by the decline in the yen, but going forward, with competitiveness restored, earnings will be the driver for further gains. The recent pickup in first quarter GDP growth of 3.5% (annualized) was led by exports and consumption. As deflationary expectations change to inflationary, growth in the Japanese economy will begin to look sustainable, thereby giving earnings a boost and sending the Nikkei higher.

REITs

Property, specifically real estate investment trust (REIT), provides a good investment alternative in the current low interest rate environment. Due to the preferential tax structure, the dividend payout by REITs is high.

Since most of the REITs issued are in developed markets where monetary policy is very loose, there is a natural tailwind to support rising prices, especially since the Fed continues to signal that monetary policy is expected to remain loose for the time being. Coupled with the fact that the US and Japanese economies continue to grow, it is likely that REITs will see higher revenues from lease renewals.

Finally, property markets in the developed world are far from their peak. After suffering from recessions since 2006, US property markets have begun to turn the corner. Even in Japan where the property market has been in the doldrums for years, there are initial signs that the property cycle is turning up. A rise in demand for property will boost the REITs sector, driving their share prices higher.

Tactical Outlook

While we may favour these two sectors for investment, we remain mindful that the global bull market is four years old and is probably at a mature stage. The odds of a bear market happening is clearly higher as compared with 2009, but as of now, the evidence does not suggest that a recession is imminent. Investors are continuing to buy into cyclical stocks and riskier bonds, a sign that recession expectations is low. Monetary policy continues to be accommodative. Hence we are willing to continue investing in risk assets until the signs suggest otherwise.

Portfolio Changes

For the cash portfolios, we are recommending taking a position in Japanese equities and global REITs. For CPF and SRS portfolios, we are recommending a switch from long term bonds to short term duration bonds in anticipation. Expect to see online notifications on your portfolios in the coming week. Please consult your advisers if necessary.



References
1. At last, Japan’s government gains confidence in its economy—and so do its consumers. 20 May 2013. Quartz.

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