Investment Perspectives: Are you big in Japan?

20 Feb 2024

Investment Perspectives: Are you big in Japan?

Japan hasn’t been a particularly well-loved market over the last few decades but convincing performance in 2023 has well and truly put the cat among the pigeons, and all eyes are on how far this new direction of travel will go.

What’s the performance story? Japan outperformed the US market last year in local currency terms (27.57% vs 25.67%). At the start of 2023, the Japanese yen was at 130 against the US dollar and went up to 150 in November. As recently as 2020, it was close to parity with the US dollar at 100 and if we look at the ‘major’ currencies, only the South African rand performed worse than the yen last year. And, if you’re wanting definitive proof, consult the esteemed Big Mac index which shows that you’ll pay 5 dollars 69 cents for a Big Mac in the US but a mere 3 dollars and 4 cents in Japan. The strength of sterling and the US dollar has reduced returns for some investors, but the significant weakening of the yen continues to attract foreign investors.

For a sterling investor, over a 3-year period, Japan has outperformed Asia and emerging markets but is still a laggard when compared to the UK, Europe, and the US. The consensus forecast is for 2% growth in 2023 and less than 1% growth in 2024, which may not seem quite so outstanding, but it is higher than the forecast for the UK and Europe.

What’s happening with inflation in Japan? For the last 25 years, inflation has largely remained below 2%. In early 2023, it rose above 4% but remained well below the dizzying heights of the UK and Europe. The Japanese government and central bank are confident they can soon hit the 2% target and maintain it, which will create a confident backdrop for investors.

What about interest rates? Interest rates in Japan were cut to zero in 1999, well before the GFC, and basically stayed there for 25 years. The current level of -0.1% was reached in 2016 so it’s safe to say that low inflation and interest rates have become the norm in Japan. With the recent increase in inflation though, there are indications that the interest rate pattern needs to change. Yield curve control has already been tweaked over the last 12 months, with the 10-year JGB yield of 1% becoming a reference point rather than a cap and there are many commentators suggesting this will be removed altogether.

What’s the rhetoric? A structural end to deflation and steady economic growth. The Nikkei 225, the stock market index for the Tokyo Stock Exchange, reached its highest level in 1989, approaching 39,000 before beginning a close to 25-year downward trajectory falling below 10,000 in 2002 and again in 2013. A momentous rebound in recent years has meant that the index is now tantalisingly close to the all-time high.

What’s happening at a corporate level? Prime Minister Kishida is pushing corporate prosperity and incentivising companies to perform better. The Nikkei 400 index - a collaboration of Nikkei, the Japanese Exchange Group, and the Tokyo Stock Exchange, was launched to encourage better corporate governance and shareholder value. Companies are scored based on return on equity (ROE) and operating profit, overlaid with qualitative factors relating back to corporate governance and disclosure to the end investor. Historically, Japanese companies have taken a defensive stance, but hoarding cash doesn’t maximise returns. The levels of net cash have reduced over the last couple of years and the number of dividends and share buybacks has been on the increase as a result. Cross-shareholding is discouraged with independent management promoted as the way forward and from August, the ratio of female directors must be at least 30%. These big shifts in and out of the boardroom will generate improved corporate governance and lead to better outcomes.

Fund management groups have differing investment approaches, but they collectively recognise the evolution of the backdrop in Japan and the unharnessed potential. The Tokyo Stock Exchange, in relation to their Corporate Governance Code, has asked companies trading at a Price to Book of less than 1 (which is around 45% of the index) to ‘comply or explain’, encouraging businesses to act. Cleansing the pool and improving the overall quality of Japanese businesses gives the end investor more clarity and improves shareholders’ returns, enticing both domestic and foreign investors to the market.

Foreign investment has fluctuated over the years but what about domestic investment? NISAs, Japanese government tax-free stock investment programmes for individuals, have been overhauled to encourage domestic investors to get back into the market and to drive more investment flows into funds and equities. A new growth investment NISA will be launched, the annual limit on the newly consolidated NISA will be tripled and the tax exemption period will be abolished.

Are things easy when you’re big in Japan? There are risks: the return of ultra-low inflation, China’s potential influence and fluctuation of currency strength, but there are reassuring signs that Japan is well and truly on the up. A tight labour market should encourage wage growth, better balance sheet management and improved capital allocation will enhance the corporate outlook, and the exponential increase in the number of activist investors in Japan in the last few years adds to the sunny horizon. Things will happen while they can – things could well be easy when you’re big in Japan.

Stewart Smith, Head of Managed Portfolio Services

Katie Sykes, Client Engagement & Marketing Manager


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This information is for UK Professional Advisers only and should not be given to retail clients.The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

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