Marketing Communication
Japan is overcoming decades of deflation as wages, prices, and corporate reforms gain momentum. A tighter labour market and economic restructuring is driving this transformation and leading to growth in Japan’s economy.
For many investors, until recently the mention of Japan evoked thoughts of a mature economy, with a declining population, mired by decades of economic stagnation, deflation, negligible wages growth and negative interest rates, and an equity market that took more than 30 years to return to its 1990 pre-crash highs. However, there are some very significant changes afoot in Japan, and Nicholas Weindling, Portfolio Manager of JPMorgan Japanese Investment Trust (JFJ), who has lived and worked in Japan for 30 years, is witnessing things he never expected to see in his career. Perhaps nothing signifies these changing times more than the recent appointment of Sanae Takaichi as Japan’s first female Prime Minister.
Key among these developments is the end of deflation. Falling prices mean it is always better to wait to buy something later, when the price is expected to be lower. This has had a stifling effect on domestic demand. But now prices are rising1, thanks to the same supply chain constraints and food and energy price hikes experienced in Western economies in the past five years. The prolonged depreciation of the yen has added to price pressures. This has prompted the Bank of Japan to abandon its longstanding ultra-low interest rate policy. And wages are also climbing. Japan’s labour market is very tight, forcing companies to raise salaries to attract and hold workers. This year’s annual wage negotiation saw incomes rise by more than 5% for the second successive year, significantly ahead of inflation2. So, with both prices and real wages rising, there are good reasons to expect consumers to break their frugal habits and begin to spend. Japan’s domestic economy should strengthen accordingly.
A new era of corporate reform
But in Weindling’s view, by far the most important change underway in Japan is a revolution in corporate governance. Encouraged by the government and regulators, companies are improving their capital efficiency, unwinding cross shareholdings and returning excess cash to shareholders via share buybacks and higher dividends, to the extent that Japan now boasts the strongest rate of dividend growth of any major market over past 20 years3. This trend towards rising shareholder returns is still gathering momentum – and attracting increased interest from international investors. Valuations are still low relative to the US market, and M&A activity is rising as private equity firms and strategic buyers take advantage of the value on offer4. JFJ is benefiting - several of its portfolio holdings have been subject to takeover bids in the last two years, compared to zero in the previous 20 years5.
Other Asian economies are following Japan’s lead, and also focusing on lifting shareholder returns, but in Weindling’s view, the scope of Japan’s change is unique, and more far-reaching. Indeed, he believes the reform process is moving into a new phase, as companies reorganise and rationalise their structures, sell peripheral divisions, and concentrate on their core businesses. These efforts are likely to lead to long-term improvement in profitability levels that would be a big driver of the market.
Local presence in an under-researched market
JFJ provides exposure to this exciting potential. The Trust is the longest established and largest dedicated Japanese investment fund, supported by 20 fund managers and analysts, on the ground in Tokyo, with an average of 20 years’ industry experience. Such a sizable team has the capacity to delve into all corners of the local market, in search of under-researched and under-valued stocks that other analysts overlook. This depth of resources offers the Trust a major competitive advantage over its peers.
The Trust’s portfolio management team adopts an unconstrained, high conviction approach, which gives them freedom to invest in the most attractive investment opportunities, without being tied to the index. The portfolio has a high quality, growth tilt, targeting innovative companies with the potential to compound earnings over the long-term. As an example, Weindling cites ASICS, the world leader in running and tennis shoes, which has been consistently taking market share from both Nike and Adidas. The Trust has had a significant, and profitable, overweight position in this stock for several years5.
Weindling is determined to take full advantage of the many opportunities being generated by Japan’s corporate governance revolution. For instance, the Trust recently opened a position in IHI, a defence and aircraft engine manufacturer. In the last few years, IHI has disposed of nine different businesses, in industries as diverse as pharmaceuticals and lawn mowers, to focus on its core engine business, whose specialist, technical nature creates high barriers to entry. As a result of its rationalisation, IHI now has good margins and free cashflow, and its outlook is very positive, as it is set to benefit from Japan’s decision to step up military spending.
The effectiveness of the team’s approach is proven by the Trust’s performance track record, outperforming its benchmark on an annualised basis over one, three and 10 year periods to 31 August 20256.
In Weindling’s view, the outlook for Japanese equities is as good as it has been at any point in the last 20 years. Recent market gains are certainly to be welcomed, but he sees scope for further significant re-rating as corporate reforms run their full course. It is Weindling’s intention to ensure that JFJ continues to capture the benefits of these dramatic changes for the Company’s shareholders.
