Market Commentary and Fund Performance

Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month end, and standardized performance can be obtained by viewing the fact sheet or by clicking here.

Market Commentary and Fund Performance for June 2024

In June 2024, the Japanese stock market hovered in a band amid attention to monetary policy developments in Japan and the U.S. It then rose toward month-end as the Japanese yen continued to depreciate.

Early in the month, while attention was focused on U.S. macroeconomic indicators involved in U.S. monetary trends, the release of employment and price indicators supported the view of slowing inflation. U.S. long-term interest rates fell sharply due to growing expectations of a near-term Federal Reserve interest rate cut. Lastly, the U.S. stock market rallied primarily through semiconductor and high-tech stocks. The same trends also drove up Japanese equity prices.

Mid-month, the Bank of Japan (BOJ) decided to reduce its purchase of Japanese Government Bonds (JGBs) at its Monetary Policy Meeting but failed to announce any specific measures. The Japanese stock market rallied as the yen weakened. After that, several factors were at play, including the BOJ governor’s statement at the post-meeting press conference that the reduction in its purchases would be “commensurate with what is required,” another statement that did not rule out the possibility of a rate hike at the July meeting, and the impact of European markets as they fell amid renewed awareness of French political unrest. Amid these developments, Japanese stocks fell at times. However, share prices recovered near month-end.

During this period, the dollar-yen exchange rate temporarily fell to the JPY-161 level, the lowest level in 37 years since December 1986. Buttressed by the weak yen, the market also gained from rising prices in banking thanks to the Japanese long-term interest rate hike. As the month ended, speculation of reinvestment in dividends was among the factors that brought Japanese equity trading to close above where it ended the previous month. As a result, the benchmark for the Fund, the Russell/Nomura Small CapTM Index returned -0.64%, while the Fund’s performance returned 0.55% (HJSIX), outperforming its benchmark.

This month’s positive contributors to the Fund’s performance included PeptiDream Inc. and Tanseisha Co., Ltd. PeptiDream’s strategic partner, LinqMed, announced the initiation of a domestic phase 3 trial for their novel radiopharmaceutical 64Cu-ATSM, targeting patients with malignant glioma. This news was well-received. In addition, brokers have raised its price target. Tanseisha rose following the announcement of its Q1 earnings call, which highlighted improved profitability and a significant increase in order backlog.

Conversely, the stocks negatively impacting the Fund’s performance included Kyudenko Corporation and Nishi-Nippon Financial Holdings, Inc. Kyudenko experienced a decline in its stock prices due to a correction following the rapid increases. Similarly, Nishi-Nippon Financial Holdings saw its stock price fall, reflecting both the rapid previous rise and a pause in domestic interest rate increases.

We made new investments that included a specialty chemical company that had been stagnant over the past few years but is now approaching a revolutionary opportunity due to the growth in the semiconductor-related business in which it had made upfront investments.

Amid rising geopolitical risks across various regions, the stock market has shown a lackluster performance. Moreover, the recent full-year earnings reports from Japanese companies have revealed plans for the current fiscal year that fall short of market expectations, contributing to the sluggish stock prices. However, through our research on individual companies, we believe that their business environments are improving and that their forecasts are conservative. With a virtuous cycle of wage and price increases, the Japanese economy is steadily recovering. Therefore, we see significant investment potential in small- and mid-cap stocks, which remain undervalued compared to large-cap stocks.

Outlook for July 2024

The electrification of social infrastructure is progressing toward becoming carbon neutral by 2050. Familiar examples include the shift from gasoline-powered cars to electric vehicles (EVs) and from combustion heating to heat pump heating. The shift from engines and hydraulic equipment to electric motors is also progressing in the industrial sector, including for forklifts and compressors. However, there are some devices for which complete electrification is not the optimal solution in 2024. The shift in automobile demand to hybrids rather than EVs is a prime example, and the electrification of ships and aircraft is not yet feasible. Various constraints are in play, including battery capacity and other technical issues, costs, environmental conditions, and compatibility with the application. These constraints are likely to be resolved through technological progress. However, in some applications, the hurdles to electrification are higher than market participant expectations. There should also be markets where existing players can expand their business by reaping the benefits of residual profit.

In this report, we would like to discuss investment opportunities using a small outdoor gardening equipment manufacturer as an example.

We are currently considering this company as a potential investment candidate due to its strength in its integrated production system for engine parts. The machinery manufacturer produces high-quality products by conducting the entire process of engine casting, molding, machining, and assembly in-house. Its in-house research on even the formulation of materials allowed it to achieve lighter weight and higher output engines. It now has a lineup of high-performance products that meet the increasingly strict emissions regulations in countries worldwide.

The firm’s primary market is North America, the world’s largest market for green space management, where planting lawns in yards and public spaces is deeply rooted in the culture. Some states even impose fines for not maintaining yards. North America is also a region where population and economic growth are expected to continue. Thus, green spaces are likely to continue expanding, leading to moderate growth in demand for gardening equipment. Another factor positively impacting the company’s performance is the rapid increase in people living in houses with large yards and taking up gardening as a hobby during the COVID-19 pandemic.

Meanwhile, market participants assume that machines will become electric, leaving the stock undervalued due to concerns about shrinking sales of engine-driven machinery. The fact that many companies have already introduced electric products to the market is another factor fueling concerns about declining demand for engine machinery. However, through individual interviews with the firm and analysis of its competitors’ business conditions, we believe that electrification will not progress as far as the market expects. Battery capacity is a limiting factor in the usage patterns of professional users who operate for long periods, and it appears that demand is not being met.

We also believe tighter environmental regulations will be a tailwind for the company. While many of its competitors are pulling out of the engine market and shifting to electric machinery due to increasingly strict emission regulations, the firm is using its integrated production system to continue complying with environmental regulations while increasing its presence in an environment that is becoming less competitive. A leading North American home improvement retailer carries several electric equipment brands but only one for engine equipment. Given this situation, we expect the residual benefits the company could enjoy are greater than the stock market has assumed and could continue over the long term.

If electrification continues to progress toward the carbon-neutral society of tomorrow, we should expect these residual benefits to eventually diminish. The accelerated technological evolution of batteries and other devices is likely to increase the penetration of electrical devices, which could pose a risk to the firm. It is well aware of this risk and is expanding its electric product lineup while simultaneously expanding its generator production bases to grow its other businesses. We also believe that the new president—who took office in 2022—holds the key to improving corporate value. We have high expectations for its efforts to accelerate the growth of its overseas business and enhance its corporate value through corporate action.

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