Investors are, rightly, getting excited about Japan again. After an extensive 34 year wait, the Nikkei Index finally reached a new all-time high. Driving this positive sentiment are a number of structural changes that are targeting improvements in corporate governance and are already creating compelling investment opportunities.
Improving economic backdrop
Somewhat surprisingly, if investors were purely concerned about earnings, Japan might have captured their attention sooner. Over the past decade, Japan’s earnings growth has been as strong as the S&P 500’s but the stock market has not seen nearly as much attention.
Views on Japan’s stock market has been plagued by its economic malaise of deflation and low growth. However, things have are improving. We’ve seen key changes in monetary policy, with the Bank of Japan (BoJ) moving interest rates out of negative territory for the first time since 2007, as inflation picked up.
There are also some positive signs for the prospects of consumer spending and growth. The recent round of wage negotiations by Japan’s RENGO trade union resulted in a 5.3% increase, which is significant in Japanese terms and way ahead of expectations and the current level of inflation, which is around 2%1. This wage increase may encourage the Japanese consumer to spend some of the large cash balances that they have been saving.
Investment opportunities from structural change
The BoJ was not the only institution making changes. We’ve seen a coordinated effort from the government, the Tokyo Stock Exchange, the Financial Services Agency, and the Ministry of Trade to improve corporate governance standards in Japan.
From our perspective, these shifts in policy are significant. They have already triggered events that we never thought we’d see in our careers. Companies with large cash balances have started to return this to shareholders, some are unwinding cross shareholdings, while others are starting to use their land assets which have for a long time been unemployed. In addition, due to changes in takeover code, we have seen an uptick in the number of hostile take-overs and management buyouts in different industries.
At the company level, there is a generational shift in management where CEOs and chairmen are retiring, and new management, with different attitudes are coming onboard to run the companies.
These corporate changes are creating massive opportunities for investors. A number of companies have now moved into what we consider premium and quality stocks due to improvements in corporate governance and management policies. SECOM is a good example. It is a large cap company which makes burglar alarms and has for a long time held around a third of its market cap in cash and securities. Last year, the company used some of these holdings to announce a big share buyback, which also coincided with a change in senior management.
Other examples include non-life insurers Tokio Marine and MS&AD, which have now become of interest following regulators’ crackdown on cross shareholdings and the potential of returning cash to shareholders.
In summary, the new wave of corporate governance regulation has created a sizeable opportunity in the Japanese stock market. While we have seen strong gains already, we think this wave of evolution is only just beginning and still has a long way to go.