When noted investor Terry Smith remarked that “a year is in fact the time it takes the Earth to go round the Sun” he wasn’t making a banal statement about physics, but a profound – though obvious – point about investing. 1  A year has no natural connection to an investment cycle for performance assessment (Smith’s point) and neither does the passing of one year into the next necessarily mark a change in the most pertinent investment themes.

As we look forward into 2024, we should be just as alive to the continued impact of existing themes, like the capital efficiency drive within corporate Japan, as we are to the prospects of change in the government, monetary regime and market leadership.  This piece is offered as a sketch of these topics – old and new – which Japanese equity investors are likely to encounter in the year ahead.
More to come for corporate sector reform
Whether the withering early 2023 report by the Tokyo Stock Exchange (TSE), calling out corporate Japan for its embarrassingly low returns and stock valuations – and crucially insisting upon change – was a new theme or not depends very much on one’s own market experience.  Earlier initiatives like the establishment of the Japanese Corporate Governance Code may have excited specialists like ourselves, but the TSE’s hard boot truly propelled the topic of Japanese change to the top of the global investment agenda.

Evidence of shareholder-friendly change is mounting.  Dividends continue to grow, and planned share buy-backs are high.  Big names are beginning to unlock capital tied-up in old-style cross shareholdings – capital which can be used to boost returns.  Nippon Steel and Hitachi delighted the market with such plans early in the year, Toyota Motor cut its stakes in telecom company KDDI and car parts maker Denso, whilst IT conglomerate Fujitsu announced the sale of its semiconductor chip packaging subsidiary Shinko Electric.  A great start, but 2024 has much more to offer.

Early adopters have grabbed headlines but by mid-2023 just 31% of Topix Prime listed companies had published the requested plans to improve returns and valuations 2. That number will be much higher in the new year when the TSE names and shames those who have resisted.  This alone should be good for stocks, but we think it will be action, not merely words which characterises 2024.  Further progress on the allocation of capital – with a focus upon cross shareholding unwinds and share buybacks – should be expected.

More exciting still is the prospect of fundamental operational reform.  Radical restructuring of low-margin divisions and carve-outs of unprofitable business lines could feature in the coming year like never before. The rare unsolicited bid by insurer Dai-ichi Life for employee benefits company Benefit One teases the potential for hostile M&A to become established in Japan and should further focus the minds of Japan’s underperforming managers.  Pressure upon Japan’s executive class – from investors, activists and the financial establishment – is becoming harder to resist; we expect to see the worst board-room blockers to finally crack in 2024.  It is a grim irony that a year and a half after his assassination, former PM Shinzo Abe’s dreams of a Japanese corporate renaissance have never been so alive.  And so, it is politics to which we turn our attention next.
Politics – out with the old, in with the new?
Abe’s posthumous economic impact continues to grow, but his political legacy lies in tatters.  A political funding scandal has engulfed the ruling Liberal Democratic Party (LDP), with the Abe faction at the centre of the storm.  Support for Prime Minister Kishida’s Cabinet is dwindling – December polling hit new lows for the third consecutive month. 3 With Kishida’s Prime Ministerial term expiring in September, a change in political leadership in 2024 is looking increasingly likely, but what could this mean for investors?

Much will depend upon to whom the top job of Prime Minister goes, if at all.  The current front-runner appears to be Shigeru Ishiba.4  The former Defence Minister has made numerous tilts at leadership, never successful.  Known as a champion of Japan’s struggling regional economies, investors’ eyes will turn to domestic names if he is selected.  Alternatively, in Yoko Kamikawa Japan could gain its first female Prime Minister.  The Ivy League educated Foreign Minister is well connected internationally, especially in the US, which investors could see as a useful attribute in an increasingly fragmented geopolitical environment.  Young, photogenic and fond of surfing, current Environment Minister Shinjiro Koizumi has also been touted as a possible replacement to the current PM.  Given his short political career it is hard to tell whether Koizumi is a prospect of substance or a cosplay version of his father, Junichiro, the popular reformist PM of twenty years ago.

Any of the above candidates would provide some sort of relief from Kishida’s staid, scandal-tainted, premiership but a market inflexion they would not make.  For the chance of that, we must look to the final candidate.

In the last race, investors – especially foreigners – were salivating at the prospect of Taro Kono as PM.  Educated in the US, fluent in English and committed to freeing Japan of the red tape by which it had been restrained for years, he pushed almost every button.  Popular with the public and regular party members but without faction endorsement, Kono was too much of a maverick for the LDP kingmakers who preferred Kishida.  Next time, his outsider status could be an advantage if his scandal-ridden party seeks distance from its seedy image. As the current Digital Transformation Minister, Kono would be only too aware of the inefficiencies – and opportunities – of Japan’s current economic structure.  Japan’s risible performance in the most recent World Digital Competitiveness Ranking – placing 32nd, just ahead of Malaysia and Kazakhstan – will be familiar with anyone who has done business in this resolutely analogue country, or indeed anyone who has seen Japan’s astonishingly low level of labour productivity.5  We are reluctant to jinx him, but if investors are looking for a political saviour in 2024 then Taro Kono could be their man.

Zooming out from Japanese party politics, the continued reorganisation of the global strategic order seems likely to be a feature of 2024.  As firms look to disentangle themselves from Chinese supply chains, and countries seek to build capability in strategic industries on friendly shores, Japan is set to benefit.  Semiconductor production is a key battleground.  The government-supported joint venture between Taiwan’s TSMC and Sony in Kumamoto is propagating its own indigenous supply economy.6 Public money is also being channelled to silicon wafer maker SUMCO, chip packaging company Ibiden and printer turned tech-wannabe Canon.7 Expect more such news in 2024.

As important as politics and politicians might be in the new year, the man who looms largest over Japanese markets in 2024 holds no elected office at all…it is Kazuo Ueda, the Governor of the Bank of Japan.  This is where we turn next.
Will the real Kazuo Ueda please stand up?
Who, or rather what, is Kazuo Ueda?  A policy genius, delicately balancing the many needs and wants of the Japanese economy?  Or a choker who has fluffed his chances to lift Japan from the negative interest rate mire?  Time will tell, but what is clear is that under his leadership, the Bank of Japan’s extremely gentle approach to monetary normalisation has had profound implications.  The differential between Japanese and overseas yields has crashed the Yen – a headache to unhedged investors and painful to small cap importers.  Exporters have loved it.  The constant expectation of higher rates has bifurcated the equity market into winning value stocks – heavy in assets and low in both price and growth – and hammered richly valued but growthier and asset-light names.  That’s the 2023 retrospective, what about from here?

It has long been our hunch that the Bank of Japan would tread the line of monetary normalisation carefully.  As a mature economy with an increasingly mature population, consumption is fragile and trend economic growth moderate at best.  No central banker wants to crash their economy, but it is understandable that the Japanese seem particularly sensitive to the risk.  Deflation – which the Bank fought so hard to escape – is a recent memory in Japan, so nobody should be surprised that its central bankers are unenthusiastic inflation fighters.

It seems more likely that the Bank of Japan sees inflation not as a threat, but an opportunity – one to curtail its distortions on the bond market; to normalise policy.  As shallow as this policy trajectory may be, most expect it to be directionally opposed to the rest of the world.  As global inflation rolls over and investors debate when and how many cuts to expect from other central banks, Japanese inflationary anecdotes continue to abound.  In December, the government announced plans to hike stamp prices by 30% but not until next autumn.8  Spring will be a key period, where we will learn if last year’s negotiated wage hikes have created a new annual presumption of pay rises.

If 2024 does see Japan finally emerge from negative nominal interest rates, equity investors will feel it.  Most notably, a shift-up in the value of the Yen versus other major currencies will be helpful to unhedged overseas investors.  The effect of lower repatriated profits might be unhelpful to some sectors in the first instant, but Japanese corporate profits have been rising structurally for other reasons; a better allocation of labour across a worker-strapped economy, for one.  A delicious prospect for investors.

Finally, just as the Ueda’s tantric approach to monetary normalisation – and the implication that a hike was just around the corner – drove the outperformance of value stocks, so the eventual shift from negative rates might signal a change in equity market preference back towards growthier names.  As investors who actively seek a portfolio growth premium, this would be a very welcome rotation.

To conclude, we turn once again to the ever-quotable Terry Smith.  In his 2012 newsletter he noted “(the Tour de France) has never been won by a rider who won all the stages, and never will”.9  His point being that just as different stages of the bike race favour certain riders, so too do the different market conditions to investors. To be in the lead when the whole race is run is the point.  To carry on this analogy, 2024 could in some ways be a different stage to that ridden in 2023.  A final move into positive interest rates by the Bank of Japan, a strengthening of the Yen and a rotation away from asset-heavy value stocks could up-end the leaderboard of winning sectors and investors.  Change at the top of government would be no bad thing, as the uninspiring Kishida has become mired in scandal.  The question is whether the next PM will be better or much better – a nice place to be.  But in other ways hope springs that 2024 be like the preceding year, just better.  A shift from words to action on corporate reform, an acceleration of better capital allocation and some radical surgery on costs would be brilliant news for Japan.

The value of active minds: independent thinking

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