This article was first published in Le Temps of 8 May 2023.
While Japanese equities were popular with Swiss asset managers in the late 1980s, the world’s 4th largest economy has now all but disappeared from our portfolios. Perhaps the time has come to turn our sights back to the Rising Sun, because after a long stock market winter, Kabuto-Cho could be in for a bright new dawn.
Despite the stock market rally at the start of the year, it is difficult for investors to find a market in which to invest with confidence, given the many geopolitical uncertainties weighing on general sentiment. With inflation fever showing no sign of abating, interest rates rising across the board, and the war in Ukraine set to enter a new phase with the imminent Ukrainian counter-attack, there is no shortage of factors to worry about.
Asia in a class of its own
In this turbulent environment, one of the regions of the world seemingly spared from the current vicissitudes is Asia, which is increasingly influenced by local factors and is thus evolving in a different cycle to the rest of the world. The recovery of the Chinese economy, boosted by the end of anti-Covid measures and a more expansive monetary policy, is being felt across the continent. This is particularly the case in Japan, which has suffered a long period of deadly deflation and has thus been the most disadvantaged market over the last two decades.
The fall of Icarus
At the end of 1989, the Japanese market was beating record after record, sustained by a frenzied rotation of investment themes maintained by Japanese brokers and the continuous issue of the famous “Japanese warrants”. It accounted for more than 35% of the world’s market capitalisation and was an essential part of any global portfolio worthy of the name. Thirty years on, it accounts for less than 8% of the total. Despite a few false starts over the years, the Japanese market has never recovered from the bursting of the speculative bubble in 1989 and has virtually disappeared from investors’ radar screens. In 2012, foreign investors had pinned their hopes on the adoption of new economic policies by Shinzo Abe’s government. But the flows generated by the prospects of a recovery have all gone back to where they came from, and international investors are once again largely underweight in the Land of the Rising Sun.
Japan has deeply changed
However, even if investors are not yet aware of it, Japan has made deep changes to its economy. On a macro-economic level, one of the most visible transformations has been the evolution of the labour market: with a shortage of labour, companies have been forced to offer pay rises that are unusual in a country where worker loyalty is no longer a given. At the same time, performance-based remuneration models have been introduced, a new trend in Japan. This long-term increase in salaries should finally support domestic consumption, which has remained anaemic in recent years. It should mainly benefit the younger generations entering the labour market. With the probable abandonment of unconventional monetary measures, Japan is also heading for a new macroprudential era, which should help the Yen to hold up on the capital markets. The appointment of a new Governor of the Bank of Japan should formalise this structural change in monetary policy.
Modernised governance
More significantly, Japan has considerably transformed its economic governance. Driven by an ageing population and a highly indebted economy, recent governments have adopted measures to boost equity investment and thus relieve an already overstretched debt market. As a result, Japan has enacted a new corporate governance code that encourages the maximisation of shareholder value. The arrival of activist investors and private equity funds has made it possible to revitalise certain companies whose capital returns were insufficient and to unwind many cross-shareholdings, an endemic evil in Japan. At the same time, dividend and share buyback programmes were introduced to support equity market valuations. The need to increase productivity has led to significant investment in technology, and mergers and acquisitions are now beginning the necessary process of consolidation in an economy that is still too fragmented. All these measures should lead to a significant improvement in corporate liquidity, and we believe that the medium-term outlook for the stock markets is excellent.
The icing on the cake
But the most important change – and one that has gone almost unnoticed – is the change in listing rules on the Tokyo Stock Exchange. The Tokyo Stock Exchange has just required all companies listed on the Prime Market (the most prestigious segment of the stock market) to implement a growth strategy designed to improve the profitability of their capital. Companies with a price-to-book ratio of less than 1 over time (i.e. a market value lower than their book value) will be forced to drop out of the Prime index and be relegated to a lower-listed segment. The requirement for companies to publish their corporate governance policies and improve transparency for investors is therefore one of the most significant changes to corporate culture in Japan, and should bear fruit in the long term.
For over thirty years, Japan has endured a long stock market winter. While there have been periods of recovery, they have been insufficient to bring investors back en masse. It was therefore easy to ignore this market, and most international investors completely abandoned the Japanese market. Yet Japan is in the midst of a transformation that should bring structural changes in favour of equity investors. For our stock market, a historic pioneer in international investment, this is perhaps the right time to turn its attention back to the Japanese market. It’s never as dark as just before dawn, and the Land of the Rising Sun could well present a resplendent dawn!