As Japanese stocks plummet, confirming a bear market, there are opportunities in small-cap and domestic-focused companies, according to fund manager Richard Kaye. Kaye, one of the co-fund managers behind the Growth Japan fund at Comgest, believes the current market turmoil presents a chance to invest in overlooked sectors as foreign investors exit certain positions. The Topix – a market-weighted index of Japanese stocks — has fallen 24% from its July highs. It fell 3.2% on Thursday, 6.1% on Friday and 12.2% on Monday, marking the worst day for the Topix since 1987. This dramatic sell-off comes as the Yen strengthened against the dollar, reaching levels not seen since January. ‘Yen is just getting normal’ Kaye believes the Yen’s appreciation is a return to normalcy rather than an anomaly. “The Yen is just getting normal,” he told CNBC’s Squawk Box Asia Monday. “Remember that for decades, the Yen was moving in the 120 – 130 band versus the dollar. It’s just going back.” This currency shift is causing a significant unwinding of the Yen carry trade, where investors borrow in low-interest Yen to invest in higher-yielding assets elsewhere, such as U.S. stocks. Kaye believes this trend will continue: “The yen carry trade is history, and we’re heading back to a very different situation.” JPY= 1Y line The move in Yen has hit Japanese companies that make most of their money abroad — such as Toyota and Sony — which previously benefitted when the Yen depreciated to all-time lows against the U.S. dollar. While large exporters and banks are feeling the pressure, Kaye sees promise in other areas of the market. “If you look even on Friday in all the bloodbath, domestic names, small cap names [were] actually outperforming,” he noted. Indeed, the MSCI Japan Small Cap index has fallen 8.6% since July 11, outperforming the 14.4% decline in the MSCI Japan index on a local currency basis. In U.S. dollar terms, the losses, while proportionate, are smaller, with ETFs such as the iShares MSCI Japan Small-Cap ETF falling by 2.1% compared to the iShares MSCI Japan ETF, which is down 8.9% over the same period. The WisdomTree Japan SmallCap Dividend Fund has outperformed both iShares ETFs. SCJ EWJ line 2024-07-11 “I particularly emphasize the whole small cap space,” said Kaye. “A lot of them are domestic names. They’ve got great earnings. They’ve been really beat up, and guess what? They’re starting to outperform in this market environment.” “And I think that’s where we’ll see a lot of the market’s general support come through, [which] is from small caps and also domestic names,” he added. Kaye named supermarket retailer Kobe Bussan as an example of a domestic-oriented business that could show strength in the market as the Yen appreciates. The stock was in the green Monday despite the broader market sell-off. The stock is also thinly traded in the U.S. The sell-off is largely driven by what Kaye terms “hot money” — short-term foreign investors who had reallocated funds to Japan, particularly banks and yen-sensitive exporters, from other markets. He explained that these investors were reallocating funds from other markets to Japan, for instance, to move away from the U.S. stock market’s high concentration in a few large tech stocks or seek diversification away from Chinese equities due to geopolitical risks. As a result, Japan became a default choice for many of these investors seeking alternatives, especially after Warren Buffett’s investment in five Japanese general trading firms Itochu , Marubeni , Mitsubishi , Mitsui , and Sumitomo . “That hot money is basically saying sayonara now,” Kaye said. “And when it’s out, we go back to more rational markets focused on those good and slightly beaten-up sectors that we talked about.” “I see quite a flood of money coming back from those investors to the domestic market, beginning in sectors like I’ve said, which have been beat up for two or three years,” he predicted.
