Can Japan tackle global trade concerns?
Those advisers and clients with exposure to Japanese equities are enjoying the ‘Abenomics’ era, which dates back to Prime Minster Shinzō Abe’s general election victory in December 2012. Since then, the Nikkei 225 index has soared by 125% in local currency terms and 126% in sterling, compared to a 30% gain in the FTSE All-Share over the same period.
And yet the very same Nikkei 225 still trades 44% below its all-time high of 38,916, reached on 29 December 1989. And the Japanese banks sector is down by 90% from the peak attained on the very same day.
Japanese equities have done well this decade but they have been a disaster since 1989
Source: Refinitiv data
This is because economic growth remains patchy and inflation continues to run way below the 2% target laid down by the Bank of Japan (BoJ), despite more than two decades of zero–interest-rate policies (ZIRP) or negative–interest-rate policies (NIRP) and multiple rounds of Quantitative Easing (QE). Huge bouts of fiscal stimulus and Government spending have yet to make more than a temporary difference. Any spurts in growth and inflation have quickly receded after the central bank or the Government tried to throttle back on any monetary or fiscal stimulus, let alone withdraw it.
So if advisers and clients are wondering why the policy pivot by the Federal Reserve – in the form of fresh interest-rate cuts – and the European Central Bank – via a return to Quantitative Easing – are receiving such a quizzical response from global equity markets, now they know why. Japan has been here before. And its failure to fuel either growth or inflation on a sustainable basis means that Japan remains the place where, metaphorically speaking at least, no Western central banker wishes to go.
That said, the Abenomics programme of monetary stimulus, fiscal stimulus and social, economic and corporate reform has boosted the Nikkei. It is also possible to argue that Japan’s economy is actually doing very well, given the number of obstacles that it faces, including the loss of the bulk of its supply of cheap nuclear fuel; a currency which has rallied by 15% against the dollar from its low of almost ¥126 to dollar in 2015; a string of natural disasters, including earthquakes and typhoons; and global trade tensions, which are seemingly starting to hit the world’s economy and therefore Japanese exports.
Growth and inflation have been uneven at best, even during the Abenomics era
Source: Refinitiv data, FRED – St. Louis Federal Reserve database
Even so, there are still challenges now facing this bullish narrative.
Japan has just increased its Consumption Tax for the fourth time in just over 20 years
Source: Nikkei Asian Review
The darkest hour comes before the dawn, however, and on 15.5 times forward earnings with a yield of 2.1%, Japan does not look particularly expensive relative to its 20-year history, according to consensus analysts’ forecasts.
It may admittedly not look knock-down cheap, either, but real bulls of Japanese stocks will point out how foreign private equity firms are swarming to the Tokyo market. KKR is flagging how Japan is its favourite arena right now when it came to looking for assets to buy and this reflects what could be a strong internal dynamic to the Nikkei and Topix indices, as corporate governance improves and shareholder returns become an area of much greater focus for management teams.
In 2018 Japan overhauled its Corporate Governance Code 9 and in 2019 the Ministry for Economy, Trade and Industry made the first changes to the rules that pertained to mergers and acquisitions for over a decade.
As a result, takeover activity is picking up, as evidenced by a bid battle for hotel group Unizo. Activist investors are starting to get traction. Sony sold its 5% shareholding in Olympus in the face of pressure to do so from American activist Third Point, run by Daniel S. Loeb. Another US activist, Value Act, had already managed to force a change of chairman at the accounting-scandal-scarred Olympus and get three independent (and foreign) directors elected to the board.
Someone clearly thinks there is value to be had and bulls will argue that Japanese equities may be poised for further gains, especially if global trade relations settle down and global growth expectations start to surprise on the upside once more.
Equally, if global fixed-income markets are right and a global downturn or recession is due in 2020, then equities could struggle, even relative to Japanese Government Bonds, where yields may be nugatory but there is a guaranteed buyer of last resort, in the form of the Bank of Japan.