After years of earnings recession, improving earnings and relatively low valuations are making overseas investments more attractive. For all the consternation over and discussion of geopolitical and macro-economic issues, what ultimately drives stocks everywhere is corporate earnings. A notable positive surprise may be coming from Japan as its market climate restructures.
Before something can go up, it must stop going down. Corporate earnings have been declining since Q2 2011 for both the MSCI EAFE Index and MSCI Emerging Markets Index. Only a handful of companies in the MSCI EAFE Index have reported Q4 earnings as of January 20, 2017. Earnings for calendar year 2016 are expected to end with 1% growth. While hardly inspiring, if the year should show positive growth as expected, it would be the first annual growth since 2011. Some of this growth will come from the energy and energy related industrial sectors, in which earnings have been declining along with oil prices in 2015 and early 2016. The positive impact of oil over $45/barrel will be evident in Q4 2016 earnings, but it will not be until 2017 that the effect is more fully apparent.
We often say it’s earnings that determine stock market performance in the long run. However, we are also interested in the shorter-term impact of estimate changes for future earnings. For almost all international markets, earnings forecasts for 2017 have increased since September 30, 2016. A number of major geopolitical events have occurred since then, including the likelihood the U.K.’s departure from the European Union will happen with more substantive changes (the so-called “hard Brexit”), an anti-European vote in Italy and the election of Donald Trump, who has promised a more protectionist U.S. trade policy. Each of these events could have dampened earnings forecasts and may still diminish earnings as the year unfolds. Yet despite these events, and others looming on the horizon, analysts have been increasing their 2017 estimates.
The Japanese economy, and for the most part its stock market, has been waning for so long it’s hard to remember that Japan used to matter to global investors. Even after years of stagnation, Japan is still the world’s third largest economy and second largest stock market at 8% of combined global stock markets. Japan may finally represent a long-term investment opportunity because there is earnings growth potential. Earnings may come in at 4.5% for 2016, and expectations are for 11.7% growth for 2017.
Japan used to be an expensive market with price-earnings-ratios regularly above 70, and at times in the hundreds, during some of the market peaks, such as 2002 and 2008. Valuations were high for two reasons; namely, Japan had extraordinarily low interest rates for years and, for all their success in gaining market share and creating global brands, Japanese companies were not as efficient or profitable as similar companies based in other countries.
Conditions are changing in Japan. Formerly, Japanese companies offered lifetime employment. Today fewer than 10% of Japanese companies still use lifetime contracts. Japanese companies are now more profitable because they are able to react to economic changes. They are more inclined to hire, and Japan’s workforce is growing, despite an aging population. The increase in the workforce has increased consumer spending, boosting consumer stocks.
Another structural component in the potential Japanese equity revival is the undoing ofkeiretsu, the system of cross holdings across Japanese companies. Sometimes corporate decisions were made for the benefit of other companies under the umbrella, rather than profit maximization or shareholder return. The number of shares held within the keiretsu system has declined dramatically. As a result, the percentage of Japanese shares held by foreigners has increased as investors gain confidence that corporate managers are working for them, not themselves, their employees or other companies within the keiretsu.
Improved earnings overseas are motivating global investors to examine areas that have been out of favor, even those that have lagged for decades like Japan. What they are finding are improving expectations for earnings, more attractive valuations, and in the case of Japan, positive structural changes in the way companies operate.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Investing is stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
- Data provided by LPL Financial.
- Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly cross many sectors and companies.
- All indices are unmanaged and may not be invested into directly.
- All investing involves risk including loss of principal.
- International investing involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk