Japan’s Stock Rally Isn’t Over. But Patience Is Key.
The easy part of the Japanese stock rally looks to be over. Some of the factors that drove it may still produce longer term gains.
The iShares MSCI Japan exchange-traded fund jumped by a quarter from late October to late March as the promise of Tokyo breaking a three-decade deflationary cycle lured global investors into low-multiple equities. It’s tapered off by 4% since then.
Reasons are manifold: The Bank of Japan halted its interest rate hikes at 0.1%, hardly a sign of economic vigor. Prime Minister Fumio Kishida’s government is polling at 26%, and mired in election slush fund scandals. Japanese retail investors still prefer U.S. securities, says Jesper Koll, Tokyo-based global ambassador for Monex Group.
“The impact of foreigners as a marginal buyer is pretty much played out,” he says.
Look closer, though, Japan bulls argue, and game-changing structural shifts are still afoot. Corporate managements are at last overcoming the trauma of the 1990s market collapse, which led to a generation of cash-hoarding and ultraconservatism, says Michael Kelly, head of PineBridge Investments’ multi-asset strategy.
“They are shaking off the 30-year deflationary mind-set,” he says.
Spring wage negotiations with leading trade unions produced the biggest raises in memory, one more positive sign that healthy, modest inflation could take sustainable hold.
Japanese policymakers meanwhile are learning to love a cheap yen, Kelly continues. Elsewhere, a currency that lost 18% against the dollar since early last year would be a bad sign. In Japan, it spells swelling earnings for its global manufacturing giants. Profit at Toyota Motor, the largest stock in the Nikkei index, leapt 81% year-over-year in its latest quarter.
A deflated yen is also pulling high value-added jobs back to Japan, largely from China, adds Drew Edwards, head of Japan value equities at asset manager GMO. “Japan is becoming a low-cost production center,” he observes.
The Bank of Japan has intervened lately as the yen approached 160 to the dollar, but largely seems content with the status quo.
Edwards is most enthused about governance reforms trickling through Japan Inc., which has long insulated itself from pesky investors through labyrinthine cross-shareholdings and old-boy boards. “We finally have a situation where all these things we’ve been complaining about are getting better,” he declares.
The Tokyo Stock Exchange got hidebound managements’ attention last year, launching a “name-and-shame” campaign for companies trading below their book value. Earlier this year, the Financial Services Authority demanded (sort of) that four top insurers unwind cross-holdings following evidence of price collusion. The $1.5 trillion Government Pension Investment Fund is pushing for better corporate performance behind the scenes, Edwards says.
Companies that embrace governance change can produce dramatic results. Edwards’ top Japanese shareholding is Mitsubishi Electric, whose CEO “threw out the Mitsubishi directors” from elsewhere in the conglomerate and “turned the culture and strategy of the company 180 degrees.”
Another pick is IT power NEC, which was ahead-of-the-Japanese-curve in shedding loss-making units, and nimble enough to expand its telecommunications equipment arm as Western governments excluded China’s Huawei. Both stocks have doubled in the past 18 months.
Japan does face at least one external threat, Kelly says: the re-election of Donald Trump, who is likely to press for a stronger yen to curb the U.S.-Japan trade deficit.
“Japan will be a market performer if Trump wins, an outperformer if he doesn’t,” Kelly predicts.