Recent coverage of Japan has been dominated by August’s Nikkei sell-off, the Bank of Japan’s decision to hold rates, and the direction of policy following PM Kishida’s resignation says Richard Aston, manager of the Chikara Japan Income & Growth Fund and the CC Japan Income & Growth Trust.
These are all important narratives, of course, but we mustn’t let short-term ‘noise’ detract us from longer-term fundamentals however loud the chattering. Let’s not forget that Japan has come a long way in the last 20 years since widespread corporate governance reform took hold.
Now, more and more companies are committing to increasing shareholder returns. The normalisation of ultra-loose monetary policy is underway and a stronger yen stands to encourage domestic retail investment into the stock market.
A different kind of crash
That is not to say that August’s sell-off in Japan wasn’t significant. It was and at one point the market saw its worst day since 1987. But, it was different.
Other crashes – like those in 2008, 2011, and 2020 – came packaged with genuine concerns over the future of whether stocks, or entire sectors, would even exist in a year’s time.
August’s sell-off, in comparison, was a reaction to a confluence of factors rather than a death knell.
The fall was prompted, primarily, by the Bank of Japan’s decision to increase rates for the first time in 17 years.
The central bank’s move resulted in swift disruption to what is known as the “yen carry trade”. This is the process by which financiers and institutional investors would borrow yen at near-zero rates before investing the currency in US Treasury bills with a higher yield to make a profit.
The Bank of Japan’s decision to hike rates, and its stated plans to increase them further, put pain to the yen carry trade. Not only did they increase the cost of borrowing, but it led to a shift in the USD/Yen exchange rate in the latter’s favour.
Yen carry traders were suddenly forced to dump shares and use the proceeds to cover interest on their Japanese debt. In response, markets worldwide fell – led by Japan itself.
No doubt, the drop was a shock. But business quickly started to revert back to normal. At the time of writing in October 2024, the Nikkei has jumped by 23% from its August lows and is back trading in the range it has been for most of 2024.
There have been some consequences. Most notably, the BoJ demonstrated caution in its September meeting by holding rates rather than raising them for a second time.
But really, normality has resumed.
The BoJ has publicly demonstrated continuing support for policy normalisation despite holding rates, with analysts forecasting another rate hike in December or early 2025. We see no reason why Japan’s new Prime Minister, Shigeru Ishiba, will stand in the way of the opportunity for economic growth.
Nor do we see any reason why he would take a different tack to the growing momentum surrounding improving corporate governance standards in the country.
Efforts to drive shareholder value by increasing returns and unwinding cross-shareholdings have remained in place since their introduction by PM Shinzo Abe in the early 2010s.
They will likely continue under the incumbent, too, just as they did under Kishida. Especially now they are being propelled by the Tokyo Stock Exchange’s calls for listed companies to improve their capital efficiency or risk future de-listing.
Pushing forward at pace
Put all these moving parts together, and things are pretty noisy in Japan at the moment. There’s a lot of speculation.
But the fundamental, long-term investment case remains in place. In fact, we’d argue that it’s stronger than ever.
Corporate Japan demonstrated its commitment to delivering increasing shareholder returns during Covid, emerging as one of the world’s most resilient dividend payers. With a record 40% of listed companies planning to increase dividends in fiscal 2025, the trend is clearly continuing post-pandemic.
Similarly, giants like Toyota are continuing to lead a nationwide unwinding of cross-shareholdings while share buybacks are on track to hit another fresh record in 2024.
Japan’s strong investment outlook extends beyond corporate governance reform alone, too.
The latest economic figures coming out of the nation are looking strong, with the BoJ noting private consumption has been steadily rising in spite of inflation in September.
Efforts to improve global competitiveness, such as strengthening Japan’s powerful semi-conductor industry, continue.
Perhaps most importantly, we believe the recent strengthening of the yen could encourage domestic stock market investment among domestic Japanese investors.
Currency weakness has long led to a preference for hoarding cash, despite a marked widening of Japan’s tax-exempt investment scheme – the NISA – in Japan. If even a small percentage of the $7.7 trillion cash pile held by households nationwide is reallocated to domestic stocks, the capital could offer a huge tailwind to the market.
Taking a long-term focus
While short-term developments can drive markets up and down, buying and holding quality businesses remains the best way of generating consistent returns in Japan.
There’s a great deal of short-term noise around market performance, monetary policy, and leadership. But in the background, this is a nation quietly and powerfully reforming its corporate governance culture while discarding the burden of ultra-loose monetary policy.
It might not happen overnight. But these trends stand to continue to drive powerful returns over time to investors in quality stocks.
By Richard Aston, manager of the Chikara Japan Income & Growth Fund and the CC Japan Income & Growth Trust
