Japan’s solid tech profile, mature industries and huge export power have gone hand-in-glove with overall economic stagnation over the past 30 years. But the recovery of the Nikkei and Topix indices to levels not seen since the early 1990s inevitably leads to questions about whether investors have to take the country seriously again as an investment destination.
This debate assumes an even greater importance as Japan seems like a benign alternative to an increasingly sclerotic Chinese market. Recent reporting suggests that even quite small Chinese start-up companies are feeling the dead hand of state interference as its leadership cleaves awkwardly towards a suspicion of private industry.
In this context, the question is whether or not Japan-focused investors can look to 2024 with confidence after such a long run of positive share price growth.
To put this into context, the Topix, which is a blended measure of the Japanese stock markets (Japan still maintains large regional exchanges), and a more representative index than the Tokyo-based Nikkei 225, has soared by 25 per cent in 2023 to outperform both the S&P 500 and other mature indices in local currency terms. The S&P 500 is still ahead in dollar terms, which according to Goldman Sachs analysts explains why some dollar-denominated investors have been reluctant to increase their exposure to Japan in 2023, even though hedging against forex risk isn’t really necessary given the dollar and the yen have been heading in opposite directions.
However, that hasn’t stopped other overseas investors from buying up Japanese shares and futures. On top of this, there are also stock market reforms that are shaking up the way the Japanese save. In fact, the changes due to take effect in January should give small domestic investors their first significant stake in the market. This comes after years of saving money in low-yielding accounts that are now uncompetitive with inflation at its highest rate in a decade at a dizzy 3.3 per cent. In a country where deflation has chewed away at the value of assets for decades, the cultural change could be significant.
A Nisa return
As the UK contemplates reforms to individual savings accounts (Isas), Japan has already announced reforms to its own tax-free stock market investment wrapper. This is the co-called Nisa, modelled on the UK's Isas and first launched a decade ago. The overhaul, due to come into force early next year, will make tax relief permanent (the wrappers currently have a finite period of tax exemption) and increase the amounts that can be saved each year.
While it is hard to predict how the country’s notoriously conservative savers will react – Japanese savers have rarely strayed beyond the comfort of Post Office bonds – merely the prospect of domestic buyers of shares increasing from a lowly base of 30 per cent of all transactions is enough to set pulses racing. It also comes at a time when tax rebates and rising consumption have fuelled expectations that core inflation will stay above 2 per cent for 2024. Japan remains one of the few countries where inflation is welcomed as an economic tonic to its underlying malaise.
This might prompt the Bank of Japan to end its ultra-loose monetary policy if there is evidence of steady wage growth and price increases for services as Japan continues to rebound from the long tail effect of the pandemic. While that could be a headwind, domestic liquidity will need to find a home, and with the right savings account, the stock market could be a major beneficiary in 2024 if it continues to significantly outperform inflation and overcome the safe draw of cash.
One other thing that might tempt Japanese investors back to the market is that earnings growth for companies has averaged just above 7 per cent this year, only just behind the US corporate equivalent, according to MSCI data. Goldman Sachs reckons that this trend will continue through to 2025, with shareholder payout ratios, which include both dividends and share buybacks, growing to 60 per cent of earnings. That figure would be the highest since 1995, excepting the artificial spike caused by the financial crisis. The return to dividend growth is particularly notable, as Japanese companies have traditionally hoarded cash rather than paying it out – which could be a sign that the lifting of deflation is finally feeding through to tangible benefits.
In fact, structural changes could be as beneficial for companies as they are for investors. For instance, one trend that seems to be boosting competition in corporate Japan – and thereby the productivity of companies themselves – is the unwinding of crossholdings. Crossholdings between companies was one of the main criticisms of the Tokyo market in the 1980s where often secret shareholdings between supposed competitors helped create cosy cartels and monopolies.
Goldman’s research shows that crossholdings have reached a low of approximately 10 per cent of the book value of all companies on the exchange. This seems to further confirm that the painfully slow corporate reforms that were enacted in the 1990s are finally yielding results in terms of better corporate transparency, as well as efficiency. The efforts of the past decade, which began but did not end with Abenomics in the early 2010s, have also had an effect. It could just be the case that the maturing of Japan’s capital allocation policies coincides with far better conditions for growth in 2024.
