The outlook for Japanese equities is looking up. Having long suffered from sluggish economic growth and a poor reputation for creating shareholder value, the Japanese stock market is now benefiting from rising consumer spending and inflation, corporate governance reforms and a number of exciting secular growth trends, from automation and digitisation to consumption and decarbonisation. Investors may want to re-set their expectations.
Brighter economic outlook
Since Covid restrictions began to be lifted in 2022, healthy consumption, rising wages and increasing tourism have been driving Japan’s economic recovery. We think these upward trends can continue. The jobs market is tight and employers have been willing to raise wages, which should support further domestic consumption. Meanwhile, strong global tourism trends and a weak yen bode well for Japan’s inbound tourist economy.
The economic recovery and weak currency are finally boosting prices in Japan to the point where inflation now exceeds the Bank of Japan’s 2% target. In April 2023, Japan’s core inflation rate, excluding fresh food and energy, hit 4.1%, its highest level since 19811. While most other developed economies have been scrambling to bring down high inflation, rising prices are welcome in Japan, where decades of exceptionally low inflation or deflation has dampened GDP growth.
Better experience for shareholders
An improving macroeconomic backdrop is certainly helpful for equity investors, but structural changes that are improving corporate governance and increasing focus on shareholders are actually a bigger driver of long-term Japanese equity returns. Indeed, efforts to make corporate boards more independent and increase transparency have been underway since 2012, when former prime minister Shinzo Abe launched several corporate governance reforms.
In early 2023, the Tokyo Stock Exchange (TSE) announced an initiative more directly aimed at improving equity returns for shareholders by urging companies trading consistently below their book value—about half of companies trading on the TSE’s prime section—to look for ways to boost their valuations.2 Share buybacks, already at a record high in 2022, have since hit another record level in 2023, which all bodes well for shareholders. Buying back their own stock is one of the easiest ways to improve valuations given many Japanese companies are flush with cash.
Japan TOPIX net income and share buyback announcements*
Buying into secular growth trends
Beyond the better macroeconomic and equity backdrop, Japanese equities also offer access to a number of themes with the potential to drive secular growth over the long term. We expect continued strong demand for automation and robotics technologies as businesses around the world strive to increase productivity—particularly as costs rise. Japan is home to some of the leading companies globally in these areas.
Digitisation is another global trend with the potential to improve productivity. In this case, Japan has notably lagged its peers—but therein lies the opportunity. The government has stepped up efforts to digitise everything from financial services to education and healthcare, creating opportunities for small innovative companies that aid the transition. Meanwhile, large established companies may benefit through increased productivity or the ability to access new markets.
Japan’s ageing population has been a long-term focus for its government. While a shrinking labour force presents an economic challenge, it will also continue to drive Japan’s strength in automation and robotics technologies and further promote digitisation and the companies that enable it. These technologies not only increase labour productivity, but also offer older people remote access to many vital services, such as online banking and telemedicine.
Japan is also highly motivated to decarbonise its economy, given its limited natural resources and high dependency on imported fossil fuels. Japanese companies are already innovating in areas related to electric vehicles, solar and wind plants and other sources of renewable energy and we expect this trend to grow with global decarbonisation initiatives over the long term.
In addition to themes driven by technology and innovation, we believe Japanese luxury goods and prestige brands are well positioned to benefit from strong regional consumption trends as disposable income in China and other Asian countries grows.
Building allocations to Japanese equities
Foreign investors have been underweight Japanese equities for many years. However, this trend may finally be reversing, with improved investor sentiment lifting the Japanese stock market in the first half of 2023. Despite the upturn in sentiment, valuations are still attractive on several metrics. The MSCI Japan has a price-to-earnings (P/E) ratio of roughly 14, which is below its 15-year average and offers a steep discount to the US equity market.3
While all of these trends—the improving macroeconomy, increasing shareholder focus and long-term growth themes—strengthen the case for investing in Japan broadly, this is a market where stock selection can make a difference. Even broad trends will not impact all companies to the same degree. For example, the economic recovery will likely have a greater impact on consumer-oriented companies while the TSE’s efforts to boost shareholder returns are more helpful to value stocks.
Furthermore, analyst research coverage of Japanese companies is notably more limited than in other major markets, which can lead to greater dispersion between winners and losers. At J.P. Morgan Asset Management our dedicated team of experienced Japanese equity investors and specialist research analysts, based locally in Tokyo, scour the market for undiscovered growth opportunities in companies that can capitalise on Japan’s structural transformation.
Expectations are on the rise for Japan’s economy and its companies. Investor allocations and equity prices could be next.
J.P. Morgan Asset Management’s investment trust offering includes two leading Japan equity portfolios