SG Yamaichi Asset Management has toured the Asian continent, meeting with fund distributors and potential investors, and has found the need to argue Japan's case as a recovery story that will continue even if China's economy hits a bump.
"Distributors think that if China fails it will have a huge impact on Japan," says Masato Degawa, senior executive officer and head of investment at SG Asset Management's Japan joint venture. "They think China is everything for Japan's recovery, but this is an exaggeration."
After several false starts, which crumpled under the weight of the ailing banking sector and its cross-shareholding relationships, the Japanese economy is enjoying its first normal cyclical recovery in 13 years, says Degawa. Banks, after years of write-offs and injections of public money, are now fully provisioned for bad loans and are actually making profits.
While banks' credit culture has not changed, they are also not lending because there is no demand.
Degawa sees the biggest risk to the recovery in the United States, although a China slowdown will also hurt Japanese manufacturers. But while big companies are vulnerable, he thinks a lot of smaller companies have businesses that will carry on regardless, which is why SG Yamaichi is now selling a pair of small-cap funds to foreign distributors.
For example, software downloading for mobile phones looks impervious to anything but total meltdown. "It's a kid's business," he says adding that the the industry is dominated by just a handful of small Japanese companies.
Degawa is optimistic on a number of fronts. He says deflation will be defeated within a year or two. "China has turned it around." Demand there has boosted factories' capacity utilization and certain things like scrap metal and paper are now out of inventory, nudging prices upward.
Japan is less vulnerable to an oil shock than it appears at first glance. While high oil prices punish airlines, it helps automakers, which export fuel-efficient cars to America. Japan is also much more energy-efficient. High oil prices will hurt, but will not drive any companies into bankruptcy.
He also positively contrasts Japan's balance of payments with the United States. Japan remains the world's biggest creditor nation, which lets it finance its admittedly large government budget deficit, a problem for politicians but not stock investors. Moreover it enjoys a large current account surplus.
This could be a problem: Degawa believes the country's foreign currency reserves make it far too exposed to the US dollar. "I do worry about a housing crash in the US that slows US growth and hurts Japanese exports." Over time the yen will appreciate, however, making Japan a good hedge for international investors, he argues.
Although last year's upturn saw the greatest upside in Japanese equities, Degawa says attractive returns can still be made over the next two or three years. In yen terms he thinks his funds can return 15% to 20% annually, versus the market consensus of 10% returns in equity markets this year. He would only take profits if sentiment gets too excited and sees another 40% to 50% gain on the Tokyo Stock Exchange this year.
"China is important but Japan is back because the market rebounded, not because companies have restructured," he says. "There's a different perception now about Japan."
