The Japan rally | financial times

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Good day. Ethan here; Rob is away this week. Fresh off their coverless debuts in April, the FT jennifer hughes and kate duguid will be back in the next few days. Today I’m talking about Japan, a personal fascination that has become headline-grabbing market news. Email me: ethan.wu@ft.com.

boom times in japan

In March, when the Topix looked normal against other stock indices, I wrote about the first signs of transformation in Japanese markets. Less than two months later, Japan’s rally is in full swing. After Warren Buffett visited Tokyo in April, global investors are in a hurrythe Topix is ​​at its highest point in three decades and Japan is outperforming everyone else:

The rally rests on three pillars:

1. A change in corporate attitudes toward shareholders, including activists. Any change this sweeper has many parents. Some foreign activist investors have mounted successful campaigns to boost equity returns, which have long been negligible in Japan. The most striking example is Elliott Management, which prompted printing conglomerate Dai Nippon to issue 300 billion yen (then $2.2 billion) in share buybacks, worth nearly a quarter of its market capitalization.

   Add to that the pressure from the authorities. The government’s plan for dual asset income, to achieve a “new form of capitalism”, sets the tone. The Tokyo Stock Exchange has also been putting pressure on Japan’s many undercapitalized companies, those with a price-to-book ratio of less than 1, to get in shape or face sanctions. Although sanctions are years away, companies are beginning to follow the new script. Buyback announcements in fiscal 2022 hit a record. Rie Nishihara, Japan equity strategist at JPMorgan, told me that the TSE reforms are having perhaps their greatest impact through the administration’s changing cultural expectations: “Japan is a culture where, even without regulations, it matters Be a role model among your peers. She points out that despite many companies pulling back on fears of a US recession, buyback announcements seem resilient:

   

   And with only 20 percent of Q1 buyback announcements coming from companies with a P/B ratio of less than 1, Nishihara expects more to come.

2. Inflation is back. The cost crisis of the pandemic and the war in Ukraine forced companies to raise prices, something that is normally frowned upon. Could Japan Finally Kill Its Deflationary Monster? Inflation excluding fresh food and energy stood at 3.8% in April, a four-decade high. Perhaps most importantly, there are some signs of rising wages as workers regain lost purchasing power. Although real wage growth remains deeply negative, companies participating in Japan’s annual rate derivation Wage negotiations agreed to a 3.7 percent wage increase, the biggest since Japan’s asset bubble burst in the early 1990s. Nishihara calls it “a transition period into a new inflationary era.”

3. A sense that Japan is a haven market in a risky world, especially for timid investors from China seeking exposure to Asia. Uncomfortably high recession risk in the US and Europe, plus China stock rally fades, makes Japan look relatively attractive. The country could also benefit from recruiting friends. Chip companies have announced a planned investment of 2 trillion yen ($14 billion) in Japan from 2021. reports Nikkei Asiaincluding names like Micron and Samsung. Finally, investors who are wary of China but want indirect exposure to its growth story see yet another reason to buy.

All in all, Rally Japan comes down to huge swings at the right time. It’s a fascinating investment story. But it has its skeptics.

1. There are signs that inflation is not taking root. Japanese inflation now has a lot to do with rising prices in one category, food, rather than a broader revival in demand. Food inflation is a Global problem, driven by the domino effect of the Ukrainian war on raw materials, as well as exceptional cases such as bird flu. Outside of tourism, inflation in services is muted. Producer prices are falling. The problem continues to be that of wages: without stronger and more sustained increases, inflation will fall. the much publicized derivation wage increases are concentrated in a few industries like manufacturing, which account for just 5 percent of employees, Marcel Thieliant of Capital Economics told me. We are at the “end of the inflationary cycle”, he thinks.

2. Corporate reform could disappoint. Measuring a change in attitude is very difficult, and Japan veterans note that management skepticism about investor short-termism runs deep. take the recent Deadpoint between activist Yoshiaki Murakami and Cosmo Energy, the smallest of Japan’s three big energy companies (with a P/B of 0.7). Murakami wants Cosmo to increase ROE and spin off its renewable energy unit, while Cosmo’s president has balked, suggesting Murakami is just looking to make a quick buck.

   Hani Redha, a portfolio manager at PineBridge Investments who made money in the Japanese markets in the 2010s, adds that even if there are a growing number of companies trying to increase ROE, that alone may be enough to attract stock pickers. . The bar for asset allocations to rethink Japan is high: “Culturally, getting enough [corporate reform] It happens that it moves the needle at the overall portfolio level, at the allocation level, it’s harder to see. . . You have an index with a lot of exposure to the auto sector, and that looks absolutely ugly to us. Japan is in the caboose when it comes to the [electric vehicle] transition.”

3. Japan is vulnerable to cyclical weakness elsewhere. Its stock market is crammed with exporters, meaning faltering global growth can quickly turn into earnings weakness for Japan Inc. A US recession could be especially cruel. As the Fed cuts rates to help the economy, the tighter rate spread would attract capital to Japan, strengthening the yen. That, in turn, would make Japanese exporters’ products more expensive in US markets, just as consumption is falling.

In general, I remain bullish on Japan in the long term. The change in attitude towards shareholders will take time, perhaps years, to materialize, but it is hard to deny that a structural change is taking place. In the short term, however, I am less optimistic. Given how high inventories have been, a reversal is likely in the second half of the year as global growth slows. That moment, when today’s optimism gives way to renewed doom for Japan, could be the right time to buy.

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