Hugh Young of Aberdeen Asset Management believes that investors should take another look at Japan.
Spring is special in Japan. The blossom of cherry and plum trees invites viewings - or “hanami” - across the country. The tradition speaks to the country’s appreciation of nature and the passing of seasons. But as the Japanese economy picks up momentum, will this rebound prove as ephemeral as the spring cherry blossom?
For the first time in a while, Japan has much to shout about. There has been good news from the domestic economy, including the re-election of Prime Minster Shinzo Abe and strong economic data, but also supportive global factors, particularly the low oil price and the US-led recovery.
The large fall in the oil price since last summer has significantly lowered costs for businesses and boosted incomes, as Japan is a large net oil-importer. On the other hand, the oil price fall may entrench the deflationary mind-set, historically a problem in Japan. What could change that is a pick-up in wages.
Japan’s retirement squeeze has encouraged many women back into the labour force and kept unemployment firmly anchored. In March, Toyota and Nissan agreed to raise basic wages by about 3 per cent this year, the largest annual increase in a decade. If others follow, the current upswing in spending may last. Part of Prime Minister Abe’s carrot-and-stick approach is a phased reduction in corporate taxes, which may have mixed results as only three in ten companies actually pay corporate tax.
Many companies are having trouble growing profits, evident from the corporate sector’s growing cash pile. Hoarding appears to be a reaction to the last crisis, as deleveraging from the bubble years of the 80s took over a decade. Compounding this problem is a lack of attractive domestic investment opportunities.
The Nikkei is at its highest since April 2000. Japanese equities have outpaced other major markets this year in dollar terms. The rally stems in part from the weak yen’s boost to exporters but also the impact on company balance sheets of converting foreign earnings back to the native currency. The yen has actually strengthened a little this year against most currencies.
Meanwhile, the Government Pension Investment Fund has committed to buying equities in bulk. Yet for investors with patience the more exciting development is that, slowly, companies are open to share buybacks or raising dividends. The push is coming both from inside Japan and outside. We welcome any move that leads to greater corporate responsiveness to shareholder interests.
Although we have no fixed view on “Abenomics” itself, our interests converge with his. Abe is pressing hard for companies to set targets for returns, to take on more non-executive directors and to adopt transparency. Persuasion, not force, appears to be his weapon of choice. Thus, the new codes are not binding but rest on “comply or explain” terms for companies to follow.
Historically, Japan has not prioritised corporate governance and shareholder rights, a stance that is becoming less acceptable. The percentage of companies with at least one outsider on the board of directors increased to over 70 per cent last year, from around 45 per cent in 2008. High profile scandals, such as the Olympus accounting fraud, have had an effect. However, the changes have been as much due to the new Stewardship and Corporate Governance codes. The latter follows the practice in Western jurisdictions of ensuring companies meet minimum standards. One hot topic is cash. More Japanese institutional investors are voicing their discontent with dividend policies, which has led to more engagement with management. The latest prime ministerial thrust is to make companies produce better returns.
We generally prefer companies with proper business models, sound balance sheets and an ability to execute. Of course, we have holdings where the pace of change could be faster and where shareholder engagement is poor, even though the company might appear to be doing the right things. What these holdings have in common is a proven ability to adapt, whether to changes at home or abroad.
Beyond the muddle
Japanese equity valuations today are still inexpensive on an absolute basis: the Topix index is trading below its seven-year average on a forward price-to-earnings ratio basis. US and European stocks are dear by comparison. True, Japanese companies are generally not investing enough, reflecting the poor state of domestic demand. Instead, Japanese companies have reduced debt. The problem, therefore, is too much corporate cash and too few investment opportunities. If Abenomics comes good, clearly that could change. Even if it does not, we think Japan is past its prolonged state of “muddle through”.
So, while the cherry blossom is replete with symbolism, it is the green shoots of recovery elsewhere in the world that will lift the country. As it is, there are plenty of Japanese companies doing just fine.
Hugh Young of Aberdeen Asset Management is the manager of the St. James’s Place Far East fund. The opinions expressed are those of Hugh Young and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James’s Place Wealth Management.
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