How the pandemic has changed Japan
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For three decades Japan has experienced bouts of deflation and persistent weak growth. And, on the face of it, investors have been right to shun it. The Japanese stock market, as measured by the Topix index, has returned just 54.8% since its peak at the end of the 1980s – compared with 802.3% for the UK’s FTSE 100 and 2,060.6% for America’s S&P 500*.
But after the past eight years of ‘Abenomics’ – monetary and fiscal stimulus and economic reforms, which have proved largely successful – things have started to change. While the S&P 500 still comes out top with returns of 255.1%, the TOPIX has returned 155.2% in that time, compared with just 54.9% for the FTSE 100**.
So what is keeping us from investing in Japanese equities? Especially when the stock market is relatively good value? According to Matthews Asia, for the past 25 years, Japan has traded at a discount versus the U.S. “In the first 15 years of this period, the discount was justified given Japan’s poor return on equity and return on invested capital,” a spokesperson said. “For the past decade, however, the market hasn’t been pricing in the positive changes achieved by Japanese companies.”
And, as the FSSA Japan Focus team points out, economic growth is not a requirement for corporate growth. “Theoretically, a fast-growing economy bodes well for corporate earnings and stock prices,” the managers said. “However, although Japan’s nominal GDP has grown by just 4% since the late ‘90s peak, Japan Inc’s corporate profits have grown by 180% over the same period.”
It’s no secret that Japan has one of the oldest populations in the world and this may be holding back investors. 28% of the population is over 65 and this number is predicted to increase to 38% by 2050***. This will have wide-ranging implications on the labour force and productivity, healthcare resources and costs, as well as savings and investments.
But this story is true in other parts of the world too, so in some ways, Japan is ahead of the curve in terms of finding solutions that other countries may adopt. And this means there are opportunities for investors.
Automation and technology firms are obvious beneficiaries, as companies seek to automate processes and replace labour-intensive functions with machines. According to FSSA, Japanese companies make more than 50% of all industrial robots and computer-controlled systems globally.
Fidelity’s Japanese equity team agrees that this is an area of opportunity, “While the Japanese generally embrace technology, in national terms they lag other countries in areas including cloud computing, digital payments and single sign on. The new government, installed in September, is adding further impetus to the previous government’s drive to digitisation. The administration has pledged to reduce mobile phone fees and establish a new agency tasked with handling digital transformation policies, appointing the Minister for Digital Reform to oversee the initiative.
“In cloud adoption, there are estimates that by 2022 Japan will trail the US by seven or more years. However, the rate of cloud spending in Japan is expected to rise from 3.0% in 2019 to 4.4% in 2022.
“In digital payments, Japan is similarly behind but making strides. The government had hoped an influx of visitors for the 2020 Tokyo Olympics would contribute to the goal of doubling electronic payments to 40% by 2025. With the games postponed to 2021, the government is pursuing alternative schemes and has other initiatives already set up.”
Matthew Brett, manager of Baillie Gifford Japan Trust, added: “It seems to us that last decade’s dependable growth themes of internet and automation everywhere remain intact,” he said. “However, at the same time, they are evolving quickly. Within the internet, it seems likely that some of the traditional ecommerce platforms or services could become vulnerable, while at the same time a new breed of software disruptors will likely provide new opportunities for significant upside. Japan is behind the curve here in comparison to other developed markets, implying a larger growth opportunity from the current juncture.”
A final area which has perhaps held back investment in Japanese companies in the past has been the conservative way in which many large Japanese companies are run. But this financial conservatism became Japan’s biggest strength last year and stood in stark contrast to many companies around the world facing cancelled dividends or even insolvency.
And this has flowed through to equity returns. The TOPIX has returned 10% over the past year – just 1.7% less than the S&P 500, while the FTSE 100 is down 8.6%^.
“We expect the dividend outlook for Japan to remain promising, with companies both willing and able to pay out,” said the FSSA Japan Focus team. “Corporate Japan’s generally low debt and strong balance sheet profile leaves it well-placed to weather any further volatility that may reappear in 2021. Meanwhile, when it comes to the economic shock of the virus itself, Japan’s ‘cluster-busting’ approach to handling outbreaks has so far been relatively effective at containing the virus, providing a boost to the prospects for domestic companies.”
AXA Framlington Japan – this fund invests in Japanese companies of varying sizes but tends to have a slight bias towards smaller companies. The manager looks firms with long-term growth prospects which are independent of short-term news flow or what is going on in the wider economy.
Baillie Gifford Japanese Income Growth – launched in July 2016, this fund aims to benefit from the improving corporate governance in Japan, as more and more businesses move towards a progressive dividend-paying policy.
Comgest Growth Japan – this is a concentrated portfolio of only 30-40 high quality long-term growth companies. The managers believe that Japan is full of under-researched companies with great capital discipline, barriers to entry and growth. Their mission is to find them.
T. Rowe Price Japanese Equity – this fund invests in around 60-100 Japanese companies of all sizes, although with a notable overweight to smaller firms. The manager aims to find businesses he believes can deliver sustainable growth, before other investors recognise their potential.
*Source: Source: FE fundinfo, total returns in sterling, 12 December 1989 to 13 January 2021
**Source: Source: FE fundinfo, total returns in sterling, 10 December 2012 to 13 January 2021
***Source: United Nations
^Source: FE fundinfo, total returns in sterling, 31 January 2020 to 13 January 2021