Reliance on Weak Yen Puts Japan Inc. at Risk, Top Fund Says

A top-performing Japan stock picker has cautioned against too much reliance on the weak yen propping up exporters profits.

(Bloomberg) — A top-performing Japan stock picker has cautioned against too much reliance on the weak yen propping up exporters profits.

With the currency nudging toward a three-decade low, some firms may be vulnerable to the sustainability of earnings, said Colin McQueen, who manages the T. Rowe Price International Value Equity Fund. His fund has beaten the majority of its global peers investing in Japan in the past 12 months with returns of about 23%, according to Bloomberg data.

“Some of the export-oriented businesses at present have done well from the weak yen,” McQueen said in an interview. “You might find a bit of rotation in terms of which stocks are benefiting in a more inflationary environment,” he said. 

McQueen’s warning came amid concerns that markets are heading toward an inflection point after comments from Governor Kazuo Ueda fueled speculation the Bank of Japan is laying the groundwork to normalize policy. This may trigger a repositioning of portfolios globally in anticipation of a tightening of liquidity in the world’s last holdout for negative interest rates.

Japan is the $10.4 billion fund’s top geographical allocation, accounting for 18%. It’s one of the best performers among 43 peers with assets totaling $5 billion and more and 10% of their investment in Japanese equities. That’s based on a minimum of five years of historical data compiled by Bloomberg.

McQueen took over the fund in 2019, and describes its approach as contrarian, taking advantage of opportunities where investors are overly worried in the near-term, and buying good companies that are trading at discounts.

“Japan has probably been a bit more of a stealth opportunity,” the 56-year-old fund manager said, as many of the Asian nation’s companies have become very attractively valued. “Probably over the last three years, it’s been quite a good period to be a relatively contrarian stock picker,” he said. 

The country’s stocks are still appealing, and the rally may have further to go, said McQueen. Japan’s world-beating equity market has surged over 29% this year. London-based McQueen said that corporate governance reform such as stronger balance sheets and more effective use of assets may drive more gains. 

To be sure, the rally in Japanese equities to a 33-year high leaves them vulnerable to a potential pullback, and McQueen himself is cautious about selecting the right stocks as the nation’s inflationary outlook shifts.

“Interest rates in other parts of the world have moved up, so that exposes a bit more of a gap for Japan,” he said. At the moment though it’s important to make sure “you’re not ending up with stock picks in the portfolio that require the same economic environment to take place to succeed,” he said. 

The yen has slumped 11% against the dollar and is the worst performing Group-of-10 currency this year.

Top Holdings

Toyota Motor Corp. is the fund’s top Japanese holding, despite McQueen’s concerns about the yen. McQueen has added more shares since the second quarter, when Toyota’s price-to-book ratio was close to its Covid low. The world’s No. 1 carmaker has climbed about 56% this year to a record high. 

“The company is very asset rich and the likelihood that they might do something to realize some of that value has potentially gone up,” the fund manager said. Positives include asset restructuring, better sales and potential tech investments, he added. 

The fund has also outperformed its benchmark with picks such as drugstore chain operator MatsukiyoCocokara & Co., with McQueen expecting more tourists to come to Japan and sector consolidation to benefit the shares, which have already risen 42% in the past year, almost double gains in the Topix. 

It also started buying Kao Corp. this year because of potential for the personal-care products maker to pass on price increases. 

He credits the fund’s performance to discipline in picking stocks, idea-sharing, and working with Japanese-speaking research analysts in a bottom-up approach that’s outstripped the S&P 500 over the past 12 months. 

Here’s more on McQueen’s views:  

  • He likes banks such as Mitsubishi UFJ Financial Group Inc., which would benefit from potential interest-rate hikes.
  • “There are scenarios in which we see a more reflationary environment and stronger monetary policy, where banks would be one of the major beneficiaries,” he said.
  • He also sees opportunities around property stocks like Mitsui Fudosan Co., which usually fall as inflation quickens. He says much of the negativity has been priced in and may be “overdone.”
  • McQueen said there’s potential for a recovery in tourism-related stocks, as visitors to Japan increase, especially from China.

(Updates equity indexes in eighth paragraph, other share prices throughout.)

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