142. How women could change the fortunes of the Japanese economy

15 July 2021 (pre-recorded 13 July 2021)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Sam Slator (SS): I’m Sam Slator from FundCalibre and today I’ve been joined by John-Paul Temperley who’s deputy manager on the AXA Framlington Japan fund. Hi John-Paul.

John-Paul Temperley (JPT): Hi Sam, nice to have you on the call with me.

SS: You’re very welcome.

[INTERVIEW]

[0:17]

SS: The big investment topic at the moment is inflation, because it’s hit 5% in the US, it’s creeping up here in the UK, but actually Japan’s had the opposite problem for quite a few years now, it’s been in a deflationary environment. So presumably, for your asset class, a bit of inflation’s got to be a good thing. Is that correct? And are you actually seeing inflation come through in Japan?

JPT: Yeah, the most recent numbers actually are for some very, very modest CPI inflation. So over the proceeding 12 months, we’re seeing just something north of 0.1%. As you mentioned, Japan has been in a structural sort of modest deflationary phase over the last 10 to 15 years. And excluding, if you like, the COVID year-over-year impact, that situation is continuing. But that isn’t to us at least, and I don’t think the market either, a particularly either a big surprise or something that is altering our stock selection in any particular way.

SS: So would you expect the inflation to tick up any more or is it still a fundamental problem in Japan then?

JPT: Yeah. Well, if you think in terms of just demographics, simply put the Japanese population has peaked and the size of, the absolute size of the workforce has also peaked. So on those basis alone you could say that the demand-led inflation in Japan is to some extent, you know, structurally challenged. However, countering that and something that is interesting us, and I think is quite an important topic for listeners on the podcast today, so for example under the leadership of Prime Minister Abe, and more recently picked up by his successor Prime Minister Suga, there’s a long term emphasis being put on bringing women back into the workforce. And that will certainly be helpful in terms of bringing some greater inflationary effects back into the economy. Japan has definitely lagged behind the West in terms of providing childcare, for example, and that’s been a barrier if you’d like to women coming back to the workforce after having a family. So Japanese companies, led by government policy, and also I think increasingly a sense of a societal duty that they want to perform, are you know, doing things like providing nursery care, kindergarten care facilities, even within their own company, so that women can both rejoin the workforce, but also do so with the comfort of being able to look after their families when they come back.

[3:27]

SS: So you’ve just mentioned there the transition of Prime Minister last year from Abe to Suga. Suga’s actually following all of Abe’s, they called it Abenomics didn’t they, so the changes that he wanted to make to corporate Japan. Suga’s actually continuing all of that is he, there’s no changes?

JPT: Correct. Essentially ,he’s just picked up the baton of what Prime Minister Abe had put in place. So in terms of corporate governance reform, that was a big one, and in fact, I would say, arguably, he’s brought to the party something that’s definitely another area where Japan has lagged behind the developed world. So he’s brought into place policies surrounding digital transformation. And obviously that’s been a big thing globally over the last few years, but it’s something that you know, Japan has probably been you know, behind the curve, let’s say. So in… so in fact, Suga’s come in and already very early doors initiated a policy to bring digital transformation at the forefront of corporate’s minds and force that through. So it’s still not uncommon in small Japanese, sort of, family-run businesses for you know, day-to-day admin to be done using fax machines, people signing off with old-fashioned ink stamps, which is what Japanese people historically have used instead of a signature. And you know, even just things like that, you know, getting rid of fax machines, you know, getting the internet connections, you know, up and running and, and Wi-Fi, and so on, that kind of stuff, it sounds simple, but it’s stuff that Japan – certainly at the smaller end of the corporate scale – hasn’t really embraced fully, but that’s changing.

[5:32]

SS: And I had a quick look back at the stock market performance since Abenomics actually began, which is just shy of 10 years ago, and while everyone’s sort of been looking at the US stock market and how that’s led the world, actually in local currency terms, the Japanese stock market, the Nikkei is actually kept up with the S&P 500 right up until March this year. So I had a couple of questions around this, the first being, what happened in March to stall performance?

JPT: Before I answer that, I’ll definitely concur that, you know, Japan’s had a, what I would call a kind of stealth move. So yes, the US obviously has gained all the headlines with the, you know, the big moves in the, some of the, our favorite FAANGs and tech stock names. But actually, as you say, the Japanese market – admittedly off a low base – has performed remarkably well. We’re not surprised by that because you know, valuations were incredibly attractive back at the dawning of Abenomics. And indeed, you know, as we, we’ve just touched on, Prime Minister Abe, and we think now also subsequently Suga, are doing a lot of good things in Japan and changing things for the better.

But you are correct. We cannot deny that in the short term, the market has somewhat stalled. I think that’s easily explained, I’m not going to sort of be flippant about it, Japan I think had an early, Japan’s early experience of COVID was probably better than ours in the sense that it didn’t.. COVID infections didn’t really take off March, April last year. And I think because of that, I think that the government was slightly complacent about ordering vaccines. The knock-on effect this year was that Japan has definitely been slower than the UK and even Europe in terms of the vaccine rollout. I think that’s definitely had an impact on sentiment in Japan. And that I think alone has been a kind of reason why sentiment-wise the market had a kind of somewhat slower relative performance year to date.

However, if you look back over a 12-month period, if you included the second half of last year, Japan is still basically neck and neck performance-wise with the US and Europe. So I think it’s just a question of timing, and actually we are looking at the other way around, you know, looking ahead we’re very positive on the market. We see corporate profit coming through, we think projections are quite conservative, we think valuations are supportive. So while we don’t think Japan necessarily is, you know, a million times better than, than other markets, however, we definitely very comfortable holding on and topping up Japan maybe after a period of relative modest performance into the second half of the year.

[8:38]

SS: And you mentioned there that the S&P 500 was driven in a large part by the big FAANG stocks, the big technology stocks. Japan is sort of, it’s known for its technology, but it tends to be more in the parts area rather than the sexy internet type companies. Are there opportunities there, and can you perhaps talk to us a bit more around sort of automation, robotics and AI, which is what these themes that are emerging, that Japan seems to be quite well-placed to respond there?

JPT: Yeah, I love the way you used the phrase the sexy internet space. It’s actually, if you look at the profit margins that Japanese companies earn in terms of making hardware that goes into semiconductor chips or high level functional high function materials that go into the technology space, they’re earning often because of the fact that they have global number one or very high 40% – 50% market shares in many cases, they’re earning 30% to 40% operating margins.

Companies that are just, let’s say, dare I say it in the internet service area of the economy. And I don’t need to name names in the, you know, we know the names in the US, you know, they’re earning margins, which are probably half of that. So yes, they’ve had fantastic growth and, you know, I’m not gonna sit here and argue that that growth can’t continue, but, you know, equally, arguably some of the kind of high-level growth that we’ve seen through the last sort of 10, 15 years of digital transformation and the improvement in that we’ve seen, you know, maybe that the rates of growth will slow down and conversely, the areas where Japan’s you know excels in the world in terms of, you know, hardware and manufacturing in the, you know, the high technology space, you know, that is actually going to see structurally very strong demand.

So, you know, whether it’s semiconductor production equipment or high-level functional chemicals also in, onto the space in terms of you know, next generation pharmaceuticals and biotechnology, Japan in many areas leads the world in terms of intellectual property rights. And, you know, that’s very, obviously an area that, you know, we think Japan is not just keeping up, but actually leading the world.

[11:09]

SS: And Japan’s obviously had a very successful car industry as well. So, what’s going on there in terms of electric vehicles? I’m assuming that’s quite a good opportunity too?

JPT: I think that I’ll say it, this is a very interesting juncture, and I think Japan is definitely, along with you know, the let’s say the German car industry, you know, Japan has a very strong position in terms of being some of the most efficient producers of conventional internal combustion engines. However, I think, you know, clearly there’s going to be this shift to EV, which is, you know, beginning right now and, you know, inevitably going to, you know, take, a leap forward in the coming decade.

One thing I think we would say is in Toyota, Japan has arguably the most profitable and strongest automotive conglomerate in the world. And in fact, Toyota, they have their fingers in a lot of pies and also in the supply chain as well. So they are, I think by purely being extremely profitable and crucially they have already in the last two decades transitioned very successfully from traditional combustion engines to being very profitable in hybrid production. So we think they have already a strong lead in the automotive space.

And I think it’s important to differentiate between the automotive market in let’s say Europe and the UK, and compare that with the US and Asia and developing markets. So you’re right that regulation means that in the UK and Europe EV is going to become, you know, we think the kind of defacto standard by 2030. However, the rate of change is significantly different in places like the US, where excluding California, we think, you know, there’s still very much going to be a place for combustion engines and probably as a kind of halfway house hybrid. And then if you move to the developing world, Southeast Asia, Africa, South America, there just isn’t the provision or the economic ability to provide enough EV infrastructure. So in those areas hybrid definitely has a very, very strong future. And for that reason, we think Toyota is going to be very much the market leader, not just now, but in the future.

SS: That’s really interesting, thank you very much.

JPT: No, my pleasure.

SS: And if you’d like to find out more about AXA Framlington Japan, please visit fundcalibre.com and don’t forget to subscribe to our podcast.