Japan made global headlines at last year’s world cup after beating Germany and Spain. In 2023, the country could spring another surprise, but this time not on the football field. Its investment markets are where the country could shine this year and beyond. Japanese stocks are expected to benefit from a combination of low valuations and idiosyncratic tailwinds, which could translate into 11% gains this year on the TOPIX, the index which tracks domestic stocks listed on the Tokyo Stock Exchange’s prime market, Morgan Stanley believes.
And it appears that investors are anticipating a strong performance with more than $7bn (£5.7bn) pouring into Japanese equities in December alone. Such bullishness is expected to continue and for good reason. “In 2023, we expect Japan’s equity market will continue to prove itself a strong platform to invest in Asia,” says Richard Kaye, portfolio manager of the Comgest Japan Equity Strategy. “Its companies are heavily exposed to the pan-Asian market as providers of key technologies, from automation to semi-conductor equipment, and from electric vehicle engines to diagnostics.”
Japan has, Kaye believes, the strongest aspirational consumer brands in Asia. This he bases on “its history, geography and convenience – with strong scores on liquidity, governance, balance sheet strength and listed history”.
This would put Japan in an elevated version of the different path portfolio institutional highlighted it was on in September last year. In the piece, we concluded that Japan is not just an outlier, but a potential alternative to the woes evident elsewhere in the investment world.
A strong start
On this theme, Ken Maeda, head of Japanese equities at Schroders, highlights how the country has emerged into the new year in a strong place. “Japan entered 2023 as a clear outlier among developed markets in terms of the outlook for economic growth, monetary policy and inflation,” he says.
One in which on-going developments do not hinder but boost its standing. The lifting of Covid restrictions on visitors to the country is one. “With the domestic economy finally re-opening, we see many companies well-positioned to continue to grow profits in the coming year,” Maeda adds.
Another asset manager told portfolio institutional that Japan looks relatively resilient due to solid corporate earnings from the economy’s re-opening, attractive valuations and smaller inflation risk compared with other markets.
Such a positive outlook is given further credence by Hiroyuki Ueno, chief economist at SuMi TRUST, one of Japan’s largest asset managers, who identifies the sectors he believes could benefit. “2023 will bring challenges but the Japanese economy is firmly on the road to recovery and is set to expand,” he says. “Expansion will be mainly due to a rise in capital investment in industries that were partially suspended in 2022 due to supply constraints – such as semi-conductors – and growing private consumption, driven by the resumption of economic activity, particularly in the service sector, following the Covid pandemic.”
Opportunities for investors, therefore, look good, potentially in a big way. What could emerge is a focus on real growth – connecting investors to applicable companies that have real growth appeal.
Kaye nails these down as key points of investor interest across different sectors. “In our view, the top 1% of Japanese companies – like Dexerials, Lasertec, Sysmex, Toray and Sumitomo Metal, offer unique technology in diagnosis, aerospace or electric vehicles – are attractive,” he adds.
Societal changes
In addition, changes in Japanese society, such as more women entering the workforce, are causing old industries to rationalise, lifestyles to evolve and the country to accelerate its already advanced efforts to generate cleaner energy.
Again, Kaye identifies companies of interest. “The companies that aim to capture these growth trends include Recruit, a human resources group helping women return to the workforce; NTT Data, an IT services and consultancy group benefiting from the post-Covid drive for digital efficiency in Japan; and Tokyo-based renewable energy provider Renova,” he says.
Putting the number of positives together makes for a compelling case for Japan. That positive outlook includes Japan having the highest consensus GDP growth among developed economies for 2023, the most accommodative monetary policy – when base interest rates of leading central banks are compared – and a sharply improving governance story.
On the latter point, examples include the rising number of external directors in Japan’s boardrooms. This presents under the radar investment opportunities for investors, if they do the necessary legwork, Kaye says.
“Japanese companies remain under-researched compared to their global peers and as a result, investors could find some bargains among leading, but misunderstood, companies,” he adds.
Real value
Maeda’s positive view on Japan is also supported by the scope for ongoing improvements in corporate governance to generate real value for investors. “This is partly a qualitative assessment through our discussions with company managements, but there are also measurable impacts,” he says. “These include improving return on equity and a record level of share buybacks announced in the current fiscal year. These factors improve potential returns for investors.”
Maeda adds that this feeds into the success of Japanese corporates and their relative attractiveness from an investor perspective. “Regardless of the successive delays in Japan’s domestic economic recovery, and heightened global uncertainty, Japanese corporations appear to be performing well and quarterly results announced during 2022 have been consistently ahead of expectations,” he adds.
Policy shift
But there are issues that could stall such an optimistic outlook. And the stifling influence comes from an unlikely source in the Bank of Japan (BOJ), which made a subtle but important policy shift just before Christmas. This saw the Bank announce that it is relaxing its yield curve control policy.
An obscure policy, but one that enabled the Japanese 10-year bond yield to reach 0.50%, double the size of the previous cap. Although on one level quite an opaque move, markets were taken by surprise. This is because the yield curve control policy has been, according to the Royal Bank of Canada, “a broadly successful policy to date”.
The context and rationale for the shift is not difficult to ascertain. Inflation has returned to Japan, reaching 3.8% in November last year, comfortably above the BoJ’s 2% target, and the economy is picking up momentum as it re-opens following the end of the Covid restrictions. So, the move was understandable.
But it could have negative implications for investors, according to Marcel Thieliant, senior Japan, Australia and New Zealand economist at researcher Capital Economics. “The jump in bond yields and the further strengthening of the yen following the widening of the Bank of Japan’s tolerance band for 10-year government bond yields will lower the value of assets owned by Japanese investors. Insurance firms will be most affected by falling bond prices, whereas pension funds have most to lose from a stronger exchange rate,” he says. However, he adds: “We doubt that lower investment returns carry systemic risks.”
Investors will now wonder whether the higher cap marks the onset of a more aggressive stance for the BoJ. This is because the precedent, set down in Europe, means a new and less appealing path opens up for Japan. For example, in December 2021, after European 10-year yields had been below zero for close to three years, European Central Bank (ECB) president
Christine Lagarde stated emphatically that it was “very unlikely” interest rates would go up in 2022. In fact, 2022 marked the ECB’s most aggressive rate cycle in its 24-year history, with rates climbing 2.5% within five months.
Hence, BoJ governor Kuroda might have difficulty convincing investors that further policy “normalisation” – whatever that looks like – is not on the way. But he departs the role in April, which could add to the potentially bleak outlook, or at best, a great deal of uncertainty.
Global impact
The BoJ’s move could have ramifications globally. It is the world’s third-largest central bank, so monetary stimulus in Japan has added to global liquidity for several years now and has been a factor in pushing yields lower across the globe.
“In this context, as this policy starts to reverse, it could contribute to causing global yields to rise, particularly as the move is happening at a time bond markets have been shaken by ongoing hiking cycles,” says Frédérique Carrier, head of investment strategy at RBC Wealth Management. “This vulnerability was on display during the quasi run on UK sovereign bonds last Autumn.”
If this is a valid comparison then Japan could re-join the wider global economy and be in for a difficult time. This presents Japan diverging from its different path to be in the same depressing lane as the rest of the world.
To illustrate the point, the detail seems to add up – the BoJ policy change, on the heels of hawkish Federal Reserve comments and an aggressive ECB meeting in December, seems to have led to a higher 10-year Treasury Inflation Protected Securities (TIPS) yield – the market’s estimate of the 10-year real yield after inflation.
The TIPS 10-year yield had plateaued from the end of September and fell in November as market expectations increased that the interest hiking cycle could soon be near an end.
But while the exact timing of this decision may have surprised markets, it was, for some investors, an issue of Japan hitting a turning point – and it had to turn.
“As 2022 evolved, the Bank of Japan’s policy became increasingly irrational,” an asset manager told portfolio institutional. “Maintaining unlimited quantitative easing while also intervening to support the yen were simply incompatible policies and something had to give eventually.”
Different stage
But while the negative path is clearly a challenge to the positive outlook, it is far from inevitable that Japan will take this road. In fact, the paths open to Japan are still strongest in the pull towards a more positive highway. “While a global recession is now looking increasingly likely, Japan is at a different stage of its economic cycle and there is potential for GDP to continue to grow above its long-term trend rate in 2023,” Maeda says.
There are also potential positive currency implications. After the BoJ policy announcement, the yen, which had been chronically weak for most of 2022 due to the central bank’s ultra-accommodative policy, surged by close to 4%, achieving its largest daily gain against the US dollar this century.
The yen’s move adds credence to the widely held view that the US dollar’s strength could well wane over 2023. This, in turn, could remove an important headwind for emerging economies, which typically suffer from a strong US dollar, a currency they tend to borrow in.
This potentially makes Japanese equities attractive. “We think they should benefit from the rebound in the domestic economy while the return of inflation has led to a sea change in corporate pricing behaviour as businesses start to adjust prices upward for the first time in decade,” Carrier says.
Another path
Of course, there is another path that steers between Japan being a sweet investment success and one that tanks. That is one that maintains the investment positives while having to deal with the hard reality of joining the path marked out by the global economy. A third way of sorts.
There are though clearly important positives and sometimes specialist themes for investors to pick out when choosing which path Japan is set to go down. Another is the theme of embracing greater sustainability within Japanese corporates, which could act as a major seed that could grow in the soil of Japan.
“As Japanese companies realise the benefits of sustainable business practices, they will continue to develop new sustainable strategies to incorporate these into their operations and investments,” says Sasja Beslik, chief investment strategy officer at SDG Impact Japan, a United Nations programme.
“Whether driven by financial incentives or a desire to do good, the shift toward next generation of ESG investing is gathering momentum in Japan and is likely to continue to gain ground in the years to come,” he adds.
In this way, Japan could be creating a whole new investment path for itself.
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