At the European Union (EU)-Japan summit last week in Tokyo, EU Presidents Jean-Claude Juncker and Donald Tusk, and Japanese Prime Minister Shinzo Abe, signed the EU-Japan Economic Partnership Agreement (EPA). This agreement sends a powerful signal that two of the world’s biggest economies reject protectionism (the theory or practice of shielding a country's domestic industries from foreign competition by taxing imports). The agreement eliminates tariffs on nearly all major goods traded between the two sides.
The European Commission welcomed this deal “the most important bilateral trade agreement ever concluded by the EU” This is not a surprise since between them they account for 19 per cent of global gross domestic product and 38 per cent of goods exports. Shinzo Abe, Japan’s prime minister, hailed “the birth of the world’s largest, free and industrialised economic zone.
EU firms already export over €58bn in goods and €28bn in services to Japan every year. However, as things stand, European firms face trade barriers when exporting to Japan which make it hard for them to compete. This trade deal with Japan is the biggest ever negotiated by the EU and will create an open trade zone covering over 600 million people.
What gave rise to this partnership?
Japan is the world's third-largest economy, with a population of about 127 million. As it stands, the country is Europe's seventh biggest export market.
EU-Japan negotiations began in 2012 then stalled. It was Donald Trump's election, and the inward turn America is taking, that spurred the EU and Japan to overcome their differences.
The collapse of the agreement between Japan, the US and other Pacific ring countries (the Trans-Pacific Partnership (TPP)) has made a further case for this.
How will the EU benefit?
Two of the most important sectors effected by this agreement are Japanese cars and, for Europe, EU farming goods into Japan.
One of the most important trade categories for the EU is dairy goods. Japan's appetite for milk and milk-based products has been growing steadily in recent years. The EU's dairy farmers are struggling with falling demand in its home nations and high cost of production.
Following this deal the Europeans stand to gain the most from exports not just on dairy products, but for consumer goods as a whole. At present, duties on food are high, ranging from 15 per cent on wine to 30-40 per cent on cheese. When the deal comes into effect, some tariffs will fall to zero immediately, while others will be phased out over 15 years.
How will it benefit Japan?
Japan's main interest in a trade deal with Europe was to increase its auto exports. The EU currently imposes a 10% tariff on Japanese cars. Under the agreement, it will lower this to zero over eight years. Although cars and auto components account for about a fifth of Japan's exports to Europe, Japanese carmakers' share of the European market is only about 10%, much lower than in the U.S. or Asia which enhances the importance for such deal.
While this agreement will now allow Japanese automakers to compete on a level footing, they do need to step up their game due to the heavy investment by EU countries in the development of electric cars.
Are there any losers in both regions?
During the build-up for this agreement, EU negotiators were stressing that the deal on cars is not a “one-way street” as feared by European manufacturers. EU wanted to note that this agreement would provide greater harmonization of standards within the EU and thus hopes that this will help EU manufacturers to sell more. The European Automobile Manufacturers’ Association has so far responded cautiously, saying the deal is a “positive signal for international trade” and that it will analyse the “full implications”.
Japan on the other hand, want to push the country’s labour-intensive agriculture sector towards reform and thus EU competition would help this cause.
What kind of opportunities will this create for the investor?
An interesting investment strategy which is very common in the fund management industry is sector rotation. This strategy seeks to capitalize on the theory that not all sectors of the economy perform well at the same time. Managers using sector rotation strategies aim to rotate investment capital to sectors they identify as offering profitable investing opportunities for the longer term.
As mentioned already, the most sectors that will likely to benefit from a European standpoint are the agri-food and, to a lesser extent, pharmaceuticals, medical devices, clothing and leather sectors.
Apart from investing in single holdings which form part of these sectors one can benefit by diversifying and investing in an Exchange Traded Fund (ETF) which is exposed in, some form or another, to these specific sectors. With an ETF one can invest in a lower risk instrument, in comparison to a direct holding, and still having the opportunity to benefit from the performance of a particular sector. The main benefit of investing in an ETF is the combination of a diversified portfolio as you will be holding various stocks into one product and the simplicity of trading a single stock.
One of the major ETF providers is IShares who manage the iShares STOXX Europe 600 Food & Beverage UCITS ETF (DE000A0H08H3). This fund tracks the performance of an index composed of companies from the European Food & Beverage sector. The fund was launched in 2002 and currently has over €194million of asset under management. Another ETF in the same sector is the Lyxor STOXX Europe 600 FOOD & BEVERAGE UCITS (FR0010344861). The fund was launched in 2006 and currently has over €121 million in assets under management.
The Healthcare and pharmaceuticals sector is also set to benefit from the EU/Japan agreement and two major ETFs in this segment are the iShares Stoxx Europe 600 Health Care UCITs ETF (DE000A0Q4R36) and Lyxor Stoxx Europe 600 Healthcare UCITS Etf (FR0010344879). The iShares fund was launched back in 2001 and currently manages over €550 million worth of assets whilst the Lyxor fund was launched in 2006 and has currently over €290 million assets under management.
From a Japanese perspective, automakers and part suppliers are most likely to benefit most as they could increase their sales to Europe whereby are currently lagging behind their European rivals. Toyota's Group's market share in the EU was 4.7 percent, Nissan has a 3.3 percent share while Honda has a 0.9 percent share. Japanese suppliers Denso, Aisin Seiki, and JTEKT also stand to gain from the fall of a 3 percent tariff on auto parts.
Past performance is not a guide to future results. This information is being provided solely for information purposes and should not be deemed or construed as investment advice, advice concerning particular investments, advice concerning investment decisions, tax or legal advice. Similarly, any views or opinions expressed are not intended and should not be construed as investment, tax and/or legal recommendations or advice. No person should act upon any opinion and/or information in this document without first obtaining professional advice.