Global insights

Japan – a pivotal year

The return of inflation alongside wage growth, accelerating efforts from Japan Inc to become more shareholder-friendly and signs of monetary policy normalization have set the stage for 2023 to be a watershed year for the country’s economy and markets. Much focus has been on the Bank of Japan. That focus is justified, given the risk of spillovers to global bond markets from the potential end of the policy capping 10-year government bond yields. 

Yet we think other changes afoot - driven by regulations and authorities’ focus on reinvigorating an economy facing steep demographic challenges – are brightening the backdrop for Japanese equities. We preferred Japan to other developed market equities and now turn more positive, going overweight due to strong earnings, share buy backs and other shareholder-friendly corporate reforms. Japan is not immune to a global slowdown. Yet we see pieces falling in place – simultaneously – that underpin our relative preference for Japanese equities on a tactical horizon of 6-12 months.

Slightly more than a decade ago, late PM Shinzo Abe launched his three arrows [1] aimed at pulling the economy out of deflation. Yet after high initial enthusiasm, global investors steadily lost faith in the project given little progress around the second and third arrows: fiscal consolidation and growth-oriented corporate reforms. That spurred persistent outflows from Japan equities. See chart below. A fraction of these foreign investor outflows into equities have returned this year but we think the meaningful shifts underway augur well for a more sustained reversal.

We highlight two concurrent developments: an unusually aggressive set of edicts issued by the Tokyo Stock Exchange to spur more shareholder-friendly corporate behavior and a revamp of the country’s savings architecture aimed at guiding domestic savings into real assets, like equities. These changes happening simultaneously is no coincidence. We think it reflects authorities’ coordinated efforts to reinvigorate domestic equities. In our view, this is partly to make them appealing to domestic investors who historically have looked offshore amid lackluster returns at home but also to signal a more shareholder-friendly backdrop to foreign investors.

We think the overhaul of shareholder governance norms by the Tokyo Stock Exchange (TSE) has had the effect of supercharging Abe’s third arrow. We are starting to see companies – including Japan’s large-cap industrial, autos and consumer electronics makers - starting to respond. But there is a lot more to go. More than 40% of Japanese companies still trade below book value, according to data from LSEG Datastream as of the end of August 2023, implying the market doesn’t believe management has a credible plan to earn their cost of capital. Under pressure from the TSE, we may see this change. Companies have been returning capital to shareholders via buybacks [2] and dividends instead of hoarding cash.

Meanwhile, the return of inflation also has important consequences for savers. We think Japanese savers will likely be compelled to consider investing into assets whose value can better keep up with persistent inflation – like equities - if they want to maintain purchasing power. And Japanese authorities are facilitating this transition. From January 2024, it will be possible for all Japanese aged 18 or over to invest up to 3.6 million yen (roughly U.S$24,400) per year up to a maximum of 18 million yen (roughly U.S.$122,000) over a lifetime on a tax free basis. That has the potential for spurring a meaningful rebalance from Japanese investors out of cash and into real assets. At the end of March 2023, individual assets in Japan totaled nearly U.S. $14 trillion, according to Bank of Japan data. Cash and savings comprised 54% and equities just 11%. Getting to comparable levels seen in the European Union [3] of nearly 33% of individual assets in equities and investment shares could see more than U.S.$1.69 trillion flowing into equities in coming years.

[1] The three arrows were the key pillars of “Abenomics,” or the broad policy agenda unveiled by late Prime Minister Shinzo Abe in late 2012 to revive Japan’s economy from two decades of deflation.

[2] Japanese companies have stepped up buying back their own shares. An analysis from the Nikkei https://asia.nikkei.com/Business/Business-trends/Japan-companies-stock-buybacks-soar-to-highest-in-16-years shows buybacks hit their highest in 16 years in the fiscal year ending March 2023.

[3] Data from the European Commission shows that out of the total financial assets of EU households in 2021, equity and investment fund shares accounted for the largest share (32.9 %). source.