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Global stock markets have delivered strong returns for investors over the last five years. The US is widely seen as the standard bearer for the bull market with a near 90% gain. However another major market, often ignored by global investors, has done rather better – Japan.
Over the same five years, broadly coinciding with Prime Minister Abe’s time in power, Japanese equities have topped the US market, with a gain of 127%.
A simple check as to whether such rises in share prices are justified, or indeed sustainable, is to compare them against changes in corporate profits in the same period.
Japan looks surprisingly good on this measure, with company profits rising by over 200% in the last five years, compared to just 22% in the US.
With Japanese profits growth far outstripping the rise in its stock market, its shares have actually become cheaper. In other words, the price earnings (PE) ratio* for the Japanese market is now lower than it was five years ago. This is in stark contrast to the US, where shares have become much more expensive since 2013.
Many explanations have been given for the high valuation of US equities in recent years, mainly focused on the impact of lower interest rates. But as investors start to worry about rising rates and higher bond yields it seems likely that attention will move back to fundamentals, such as actual profits growth.
This is one of the reasons why we at Ruffer, whilst not generally known for our bullish views on equity markets, remain optimistic on the outlook for Japanese equities. They currently make up more than 15% of our portfolios, accounting for more than a third of our total allocation to equities.
*PE ratio: current market price divided by earnings per share
Chart source: Bloomberg