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Japan: Olympic sized challenges

Japan: Olympic sized challenges

Japan’s ‘Brave Blossoms’ delighted rugby union aficionados this summer with their pacey, attractive style of play. The plucky underdogs were knocked out in the quarter-finals of their own World Cup, but the host nation nevertheless won hearts and minds around the world with its well-organised and friendly tournament.

Being good hosts matters to Japan’s prospects, and large sporting events such as the Rugby World Cup are playing an important role in promoting Japan to the rest of the world. In 2016, Prime Minister Shinzo Abe made establishing Japan as “a tourism-based country” a key component of his economic strategy, setting an official target of attracting 40m foreign visitors by 2020 and 60m by 2030 – in financial terms that would lift tourism income from ¥3.5 trillion (£24bn) in 2015 to ¥8 trillion, and almost doubling again to ¥15 trillion in a decade’s time. 

According to figures from the Japan National Tourism Organization, the country is already well ahead of schedule, with 31m foreign visitors arriving in 2018, 8.7 per cent more than the previous year and quickly catching up with popular tourist destinations such as the UK. And the cash is rolling in. The Rugby World Cup is expected to have translated into a significant economic boost, attracting almost half a million foreign visitors and adding ¥219bn ($2bn) to the economy, according to analysis by consultancy EY. The Summer Olympics to be held in 2020 could have an even more pronounced effect; according to research from Bank of Japan, the Olympics will have added 0.2 to 0.3 per cent to GDP during their construction, and could deliver a  million visitors to Tokyo every day. Organisers’ hopes are even loftier – their aim is to “change the future of Japan”, and remind the world that it’s not, like its rugby team, an underdog, but one of the world’s largest and most technologically advanced economies. 

 

Hitting the wall

Yet, for all their sporting progress and success in tourism, Japan has continued to struggle to ignite its overall economic performance, and some are fearful of a subsequent post-Olympics downturn as witnessed in some other host cities. In that sense, Japan’s economy has little wiggle room. It has been seven years since Shinzo Abe was first elected as prime minister and unleashed the three arrows of Abenomics – structural reform alongside monetary and fiscal stimulus – to break Japan from its long economic slumber. And while at first they had appeared to hit their target, Japan’s economic growth has once again slipped back, partly the result of another rise in the country’s consumption tax from 8 per cent to 10 per cent (double the rate it had been in 2014). That has prompted further stimulus, this time a package of fiscal measures worth ¥13.2 trillion ($121bn) over 15 months to invest in infrastructure renewal, including typhoon repairs, and technology – far bigger than analysts had been expecting, highlighting the level of concern over the country’s latest slump.

The trillion-dollar question is just how effective this is likely to be, given how much has already been committed to stimulus programmes without breaking the cycle of stagnation. The government says the package will boost GDP by 1.4 per cent, and the Bank of Japan is said to be likely to be raising its own growth forecasts next month. But analysts at Pantheon argue the estimate is “on the generous side”, given labour market difficulties could make it difficult to put the stimulus to work and that the measures won’t fully kick in until the second half. They believe Japanese GDP growth will slow to 0.5 per cent next year, from the 1 per cent they expect in 2019. They nevertheless argue that the stimulus means further monetary easing seems unlikely – a fragile equilibrium, given the susceptibility of Japan’s export-led economy to the ripple effects of the continuing US-China trade spat. Others, like Nikko Asset Management, believe the end of Olympic construction will release huge pools of labour to replenish the nation’s ageing infrastructure, including bridges, tunnels and sewers, and begin new large-scale projects such as the $125bn World Expo 2025.

 

Social barriers

In that context, the Olympics next year takes on further significance as a talismanic turning point for the country – echoing the spirit of 1964 when the first Tokyo games marked Japan’s post-war rebirth. Japan will use the event to reaffirm its technical prowess, or “monozukuri” – excellence in manufacturing. But critics such as The Japan Times say it will not solve deep-rooted problems that are holding back Japan’s economic performance. Chief among these is demography – low fertility rates and an ageing population, exacerbated by a “homogenous and deeply patriarchal society” that inhibits the immigration and social mobility that could help Japan overcome its economic troubles. 

While Abe’s third arrow – structural reform – appears to hold the key to improving Japan’s prospects, the government believes that social problems will be solved by technology through its Society 5.0 initiative, with the aim to create “a society where we can resolve various social challenges by incorporating the innovations of the fourth industrial revolution” – including the Internet of Things, big data, artificial intelligence and robotics. Robots will notably play a big role at the summer Olympics, with car manufacturer Toyota (Jap: 7203) designing five models to support athletes and attendees at the games – a demonstration of the country’s prowess in robotics that will see them deployed in elderly care and infrastructure management amongst other uses.  

Critics suggest this is little more than “blind optimism”, though, and that more radical social reform is required – low immigration is seen as a peculiarly Japanese problem; the country has one of the lowest proportions of foreign-born workers in the world, and boosting immigration, in particular, is seen as key to offsetting demographic troubles. With low unemployment of around 2.4 per cent, labour shortages have proved a significant obstacle to public infrastructure projects.

Yet, few believe Japan’s socially conservative government wants to open up its society that far – or indeed address other social problems such as high gender inequality in the workforce. Society 5.0 could, they argue, even slow the pace of social reform, if policymakers choose instead to believe that a technological magic bullet will solve Japan’s problems. Nor will robots solve the structural demand issues Japan faces as a result of its demographic shifts – one that is starting to be felt in other mature economies, or even fast-growing ones like China; they don’t spend money, after all, and despite Japan’s technological prowess, it is not alone in envisioning the role the fourth industrial revolution will play in delivering economic improvement – competition will be fierce. A broader bet on robotics through vehicles such as Robo-Stox Global Robotics and Automation GO UCITS ETF (ROBG) may prove a better route to invest in this revolution than a broader investment in Japan.

 

Corporate reform

However, while worries about Japan’s economic future persist, reforms to the corporate sector appear to have been successful – not least prompting a steady reduction in the number of companies with single controlling shareholders and listed subsidiaries, and other improvements to governance. The upshot, as Nikko Asset Management observes, is that corporate profits have risen steadily since 2012, in negative correlation with the declining working age population. 

Meanwhile, there is a broadly held view that corporate governance reform is slowly but surely making Japanese companies much more attractive to foreign investors, to the extent that the government is proposing to revise rules around foreign ownership of Japanese shares, lowering the threshold at which the government can block foreign ownership of companies from 10 per cent to 1 per cent of issued shares. The move is seen as a method of curtailing the recent rise in shareholder activism, and blocking the threat from foreign predators, although Nikko believes that with the activism genie now out of the bottle it will gather further momentum in 2020. “Activism is no longer considered taboo in Japan… it is seen increasingly as a social mechanism necessary to create value,” the fund manager argues.  

For all of Japan’s economic travails, its stock markets have performed creditably in recent years – the Topix index has delivered a cumulative total return of 75 per cent over the past five years, and 10 per cent in the past 12 months. While that lags the stellar performance of the US, it’s in line with other major developed markets, and reflects the dampening effect of the US-China trade spat on Japanese shares in the first half of the year, before a recovery in the last quarter. Japan’s recently signed trade deals with the US and EU should offset some of the fall-out, although China is Japan’s biggest trading partner, taking nearly 20 per cent of its exports. 

Despite this, analysts believe there could be more to come, too, as corporate earnings grow further as a result of the impacts of increased share buybacks and corporate reform, along with the effect of Japan’s fiscal stimulus. Goldman Sachs expects 8 per cent EPS growth in 2020 followed by 6 per cent the following year. A pick-up in global trade could also bring a further boost, helped along by further easing in Europe and China and a possible trade war resolution. Analysts are, however, split as to whether investors in Japan should target domestically focused equities or exporters; the latter being at risk that global trade frictions continue should Donald Trump decide that continuing economic conflict with China is more attractive to his would-be voters.

However, those risks are arguably reflected in current valuations, offering investors a margin of safety, despite sensitivity to geopolitical risks. Japanese equities are already keenly priced compared with other developed markets, trading roughly in line with their five-year average of 14. Meanwhile, half of the Tokyo Stock Exchange’s top-tier companies are trading below book value, returns on equity are above 9 per cent, and – like share buybacks – the renewed shareholder focus means dividends are at record highs. The consensus is for further stock market progress in 2020. 

This week it will be 30 years since the Japanese stock market bubble burst – it has been a long road back, with an even longer road ahead if the country is to unlock the true potential of its industry. But there is much to like about the direction of travel – and still plenty of reasons to visit both Japan and its stock markets. 

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