August 2021 / VIDEO
Capital Market Insights
Japan: A fresh look at the land of the rising sun
This video features Capital Markets Specialist, Ritu Vohora. In this episode, Ritu explores why we believe Japan is well-placed to play ‘catch up’ with global markets, alongside longer-term structural drivers.
Hello and welcome to T.Rowe Price’s Capital Markets Insights with me, Ritu Vohora. As we look ahead to the autumn, volatility looms for global markets given elevated valuations, moderating economic momentum and the prospect of liquidity tapering on the horizon. However, the global economic recovery is broadening as vaccination programs progress, particularly in regions that had previously lagged. In this video, I explore why we believe Japan is well-placed to play ‘catch up’ with global markets, alongside longer-term structural drivers.
Vaccine rollout and economic recovery
The key culprit for Japan’s underperformance has been a resurgence of COVID-19 cases and slow vaccine rollout. We expect the current COVID-19 wave to peak soon, and a broad reopening of the economy could be a few months away. This should help lift services PMI, while manufacturing PMI should rise due to pent-up demand, an improvement in business confidence and a build-up in inventories, which are low relative to history. Recent macro data, such as exports and industrial production, have been robust, supported by foreign demand - over 40% of MSCI Japan’s revenues come from abroad. Japan also has the highest operating leverage among the major regions, meaning its earnings tend to bounce amid a global growth recovery. Further depreciation in the Yen may also be a tailwind for Japanese equities, particularly exporters.
Japanese valuations appear attractive particularly compared with US and European counterparts - MSCI Japan’s forward price to earnings ratio is 15.6x compared with 15.9x for the MSCI Europe and 21.1x for the S&P5001 and investor positioning looks light. To the extent that the recovery serves as a catalyst for value realization, that suggests there is greater room for Japanese outperformance.
Corporate governance and shareholder reform
There have been efforts towards both corporate and shareholder reform under Abe-nomics and subsequently Suga-nomics. Prime minister Suga took office in mid-September 2020, bringing continuity in terms of macroeconomic and foreign policies, but also a focus on accelerated reform and deregulation.
The introduction of stewardship and corporate governance codes in Japan—revised in 2020 and 2021, respectively— provide a road map for companies to become more economically productive and globally competitive - a notable secular tailwind benefiting shareholder returns.
The focus on corporate sector reform has been a key influence in the rise in company earnings and profitability seen in recent years. Part of the headwind for Japan has historically been inefficient balance sheets - often with higher cash levels and a focus on entrenched interests. Companies are now allocating capital more efficiently - buying back shares and paying higher dividends. The quality of Japanese companies and, ultimately, returns paid to investors, has continued to visibly improve, closing the gap with European and US markets.
A focus on digitalization
Suga’s focus on investing in areas of innovation such as green energy and digital transformation of the public sector, creates a runway for growth and new investment opportunities. E-commerce, digital payments and cloud penetration are still much lower than elsewhere, with scope to improve after years of underinvestment in information technology infrastructure.
The pandemic has been a headwind to Suga’s ratings and served to stifle progress on reform initiatives. However, recent underperformance of Japan equities reinforces the valuation case and the potential for value realization with economic recovery as a catalyst, both domestically, as well as being a beneficiary of stronger global growth trends. The short-term revival for Japan and its long-term target to reform governance should together provide grounds to consider allocating to Japan – it could be poised to outperform expectations beyond the Olympics medal tally.
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