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MARKETINSIGHTSQuarterly PerspectivesJapan: Looking beyond the weak yenWhile the BoJ’s additional asset purchases have driven the Japanese yen lower andJapanese equities higher, this is not the only reason for investing in Japanese equities.Admittedly, there are many long-term structural issues troubling the Japaneseeconomy, including demographics, fiscal sustainability and structural competitiveness.Nonetheless, we still see some interesting opportunities in Japanese equities.Despite Japan’s struggle to regain growth momentum and shrug off disinflation,Japanese companies have experienced strong earnings growth. Earnings revisions havebeen favorable in the past 18 months, as shown in the top chart on page 32 of theGuide to the Markets – Asia. Return on equity (ROE) and profit margins have alsoimproved. While investors may attribute this to a weak yen, this neglects the fact thatthere are some globally competitive companies in technology and robotics, above andbeyond some of the household names in automobiles and consumer electronics.The change in the USD 1.2trn asset allocation of the Government Pension InvestmentFund (GPIF) in favor of local equities will also help, but this is a long-term adjustmentinstead of a near term boost. The push for better corporate governance, includingproviding shareholders with a better return on equity, could be more critical to thelong-term outlook for Japanese equities amid economic malaise.INVESTMENT IMPLICATIONSU.S. equities seem to be an obviouschoice for investors in the developedmarket equity asset class, given theeconomic outlook and good corporateearnings performance.We believe that European and Japaneseequities can also benefit from domesticfactors even though headline growth ismediocre. Pessimism on Europe neglectssome of the downside protection thatthe central bank is providing. For Japan,a weak yen is a great help to corporateprofits, but a drive to improve corporategovernance also deserves some credit.Global Earnings MomentumGlobal Equities Earnings MomentumEarnings Revision (Upward Revision – Downward Revision / Total Revision), 3-month moving average0.40.20.0-0.232GTM - AsiaClickEarnings Revision Since Jan 2013Latest 3 ObservationsJapanese companies have enjoyedpositive earnings revisions inthe past 18 months, withimprovement in ROE and netmargins.Eq quities-0.4S&P 500 TOPIX Europe Asia ex-JP EMForward Return on Equity (%)Global Net Margins (%)20%Net income / sales16%12%8%4%Asia ex-JapanJapanEuropeU.S.EM12%10%8%6%4%2%0%JapanEMEuropeU.S.Asia ex-Japan0%'07 '08 '09 '10 '11 '12 '13 '14 '15-2%'07 '08 '09 '10 '11 '12 '13 '14 '15Source: S&P, MSCI, FactSet, J.P. Morgan Asset Management “Guide to the Markets – Asia 1Q 2015.”(Top) Earnings revision is calculated by taking the difference between the number of analyst upgrades and analyst downgrades, divided by the totalnumber of analyst revisions on a monthly basis. Earnings revision above 0 would mean that there were more upgrade revisions than downgraderevisions. Data reflect most recently available as of 31/12/14.Source: Guide to the Markets - Asia, page 326 | Quarterly Perspectives: 1Q 2015
3 Emerging markets: Hard dollar, soft oilInvestment trends in emerging markets amid strong dollarand low oil pricesA strong U.S. dollar and weak oil prices were two important themes surrounding emergingmarkets at the end of 2014. Many investors fear that a strong U.S. dollar and the FederalReserve’s normalization could triggered financial crisis in emerging markets, similar tothose in the 1990s. Meanwhile, a sharp drop in oil prices could also undermine oilproducers, especially Russia and the Middle East, as well as hurt broader commodityproducers. We recognize that some emerging markets are vulnerable in this environment,but differentiation is going to be key to capturing investment opportunities.Page 60 of the Guide to the Markets-Asia shows the dollar index, USD movements againsta trade weighted basket of currencies. This shows that, despite the surge in the USDagainst the Japanese yen and euro in 2014, the current USD index is still only at the top ofthe range for the past 10 years, and potentially still has some way to go before beingconsidered overvalued. This USD strength is partly driven by favorable interest ratedifferentials, as well as improvement in the U.S. current account position.It is important to recognize that not all emerging markets are equal in a strong dollarenvironment. Many of the Asian economies have experienced less currency depreciationsince the dollar index hit bottom in 2011. Countries with strong current accounts that areless dependent on commodities should be more resilient in this environment.OVERVIEWEmerging markets (EM) will need toface the prospects of further U.S. dollar(USD) strengthening and possiblefurther downward pressure on oilprices. Since each emerging economy isunique in its external payment positionand exposure to oil, differentiation iskey.USD strength has been a headwindhistorically for emerging markets. Thosecountries with external imbalances arelikely to require more adjustments torestore balance, which could put shorttermpressure on market performance.While all emerging markets benefitfrom low inflation brought on by low oilprices, oil importers have an advantageover exporters.Other Assets andnvestor Beha viorIU.S. Dollar Exchange RateU.S. Dollar PerformanceIndex130120110U.S. DollarIndex (DXY)1009080Real Trade Weighted70Exchange Rate Index(REER)60'86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14U.S. Current Account BalanceUSD billions50 Value % of GDP 2%00%-50-2%-100-4%-150-200-6%-250-8%'86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14ChinaKoreaPhilippinesUKSingaporeThailandTaiwanMalaysiaCanadaEuropeMexicoAustraliaIndiaIndonesiaJapanClickCurrency Performance vs. USD% since the beginning of the USD uptrend in April 2011TurkeyBrazilSouth AfricaArgentinaRussiaAsian CountriesOther EM CountriesDM Countries-51.8%-54.4%-40.8%-43.1%-30.0%-30.9%-32.3%-35.0%-25.2%-6.5%-7.8%-9.3% 93%-9.4%-15.3%-18.1%-18.4%-21.8%-3.2%-4.3%60GTM - Asia46% 4.6%-70% -50% -30% -10% 10%There are significant differencesamongst the performance of EMcurrencies since the USD hitbottom in 2011.Source: Federal Reserve, U.S. Bureau of Economic Analysis, Reuters, FactSet, J.P. Morgan Asset Management “Guide to the Markets – Asia 1Q 2015.”(Top Left) The Real Trade Weighted Exchange Rate Index is the weighted average of a country’s currency relative to a basket of other major currencies adjusted for theeffects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country’s currency, with other countries within the basket. TheDollar Index is a trade-weighted index calculated using six major world currencies. Data reflect most recently available as of 31/12/14.Source: Guide to the Markets - Asia, page 60J.P. Morgan Asset Management | 7
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