Japan is the market that investors love to hate. In the minds of many, Japan is a slow-moving, aging and economically conservative society, caught for years in a trap of low growth that makes it very difficult for business to thrive and for investors to make money. We have been investing in Japan for a long time and can tell you one thing with confidence: that view is almost entirely wrong.
The one bit that is true – that Japanese society is very old and its working age population is shrinking – has hidden benefits as well as the more obvious drawbacks. One of the benefits is a tight jobs market, meaning that companies find it hard to recruit. One of the results of this is the substitution of labour by robots or AI, which not only presents an opportunity for companies supplying that technology, but also increases the efficiency and productivity of companies making that transition. In addition, because labour has become a scarce resource there is an incentive to allocate it better, contributing to Japanese companies’ higher pre-tax profit margins.
A changing of the guard
Another misconception is that Japanese companies are dull, boring businesses too stuck in their ways to adapt to a changing world. However, such a view ignores the entirely new businesses which have been queuing up in recent years to list on the Japanese stock market. Many of these are not just new businesses but new concepts, based upon information rather than hard assets, which could be wildly profitable if successful. These businesses inject much needed vibrancy into the Japanese stock market.
Great investment opportunities are likely to be found in this new crop of potential ‘unicorns’ but success is far from guaranteed and there will be some donkeys too. One thing is clear to us, though – things are getting interesting.
Much of the apathy shown by international investors towards Japanese equities is borne of a reluctance to disentangle the obvious challenges faced by Japan as a country – its ageing population for example – from the opportunities offered by its companies. Japan as a society may be old and conservative but the corporate sector, especially new entrants into public markets, are not, with many of them fitting a very similar high-growth, asset-light, IT platform-based mould. Disruptors, in other words.
Low carbon leaders
The time for talking about the environment has given way to the urgent need for action on the environment. Japan’s government has committed to cutting greenhouse gases by 46% by 2030 and to be Net Zero by 2050. Yet Japan refused to sign the pledge at COP26 to phase out coal power and is the only G7 country building new coal fired power stations domestically.
Thankfully, the Japanese corporate sector is somewhat better positioned. Many of its companies are leaders in aspects of low carbon technology, as their piles of patents will attest (with more issued than any other single country between 2010-2019, according to the European Patent Office).
Japan’s famous automotive industry has been on the front-line of decarbonisation for decades. With more than fifteen million hybrid-electric vehicles sold since it first launched its Prius in 19971, Toyota has arguably done more than any other global company to reduce carbon emissions over the last quarter of a century. As the focus shifts from lower carbon to zero carbon, so must come the growth of pure electric vehicles (EVs). Japan exports around 16% of all EVs globally, just behind China at 20%, and has a huge amount of technological prowess in the manufacture of key parts such as batteries and motors2. If one is looking for opportunities from the net zero trend, this is an obvious place to start.
Immune from deflation? Not quite.
Even more than climate change, the animating force in global markets at the moment is inflation, with much fretting that excessive inflation in the West will be met with higher interest rates, potentially choking off the post-pandemic recovery.
Japan has remained stubbornly resistant to inflation for decades and, despite some food price inflation, this largely continues to be the case. Japan’s ageing population, along with persistently weak wage growth, acts as a brake on consumption and dampens inflationary forces. The Bank of Japan wants consumer price inflation and the Government is urging companies to bump up wages, but it does so more in hope than expectation.
From an investment point of view, we see a company’s pricing power as key. Without it, companies will be squeezed between the unstoppable force of global inflation and the immovable object of the Japanese consumer. On this basis alone the difference between the winners and the losers in 2022 is likely to be starker than ever.
In the vanguard of “new capitalism”
The person tasked with helping steer Japan through these challenging waters is the new Prime Minister, Fumio Kishida. He was few people’s favourite for Prime Minister, apart from his powerful parliamentary colleagues, and it would be a surprise if his tenure is a long one. All eyes are on his efforts to push through a sizeable economic stimulus package, designed to catapult the country out of its Covid-related malaise. This is an error. Japan has a rich history of supplementary budgets and stimulus packages with little to no lasting impact on the real economy or financial markets.
However, for a quiet man Kishida has been surprisingly profound in his call for “new capitalism”, especially in a country with an ambivalent relationship with the old one. A move to a more interventionist style of government, as one might presume a new capitalism would entail, would be in line with global trends but investors will still want to be alive to what this might mean in a Japanese context. State-directed strategic investment in semiconductor manufacture might create pockets of opportunity, for example, but an overbearing government influence on the corporate sector constitutes more of a risk.
Learn to love Japan
Instead of being a market that investors love to hate, our view is that global portfolios underweight Japanese equities could be missing a trick. Like any market, Japan will have its ups and downs over time, but the many misconceptions about the country mask a surprisingly dynamic and forward-thinking economy that is arguably well positioned to meet the myriad challenges of the 21st century.
The gears of Japan’s labour market have seized up
Japan’s growth cyclicals: opportunity or trap?
Notes from the Investment Floor: Quality can thrive through volatility
Enyasu or endaka? Japan’s currency conundrum
Japan feels the economic impact of war in Europe
The value of active minds: independent thinking
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