Invest in Japan: Land of the Rising Sun?
Exploring the Current Factors Affecting the Merits of Investing in Japan
As Japanese equities make new historic highs and inflation returns, fund managers and investors turn their attention towards the land of the rising sun. In this article we will explore this space and try to understand the investment and economic factors at play.
As with all investment or asset allocation decisions, we never have a crystal ball to consult beforehand about future outcomes. The world’s capital and financial markets are are extremely complex and are made up of many seen and unseen variables — all in a constant state of flux. This inherently makes sound investment decisions very difficult to make.
All we can do is arm ourselves with the best-quality information available and try to make an informed decision.
Background
In order to understand the dynamics at play in the Japanese capital markets, we need to go back in time to 1990 when the equity and property markets crashed on the back of a tech bubble.
The decades afterwards were known as the ‘lost decades’ and were characterised by embedded deflation and a struggling economy.
Even more importantly, it completely destroyed the Japanese population’s confidence in investing on the financial markets. This in turn created a vicious circle whereby people became doggedly-committed savers, resulting in no funds being channelled towards stimulating economic growth via bond or equity purchases.
Today the general population remains extremely risk averse with 7.7 trillion US dollars squirreled away in savings.
This risk aversion is reinforced by daily visual reminders of the property crash from 1990. This takes the form of extravagant buildings constructed during the bubble-era 1980’s, which have since fallen into decay.
Despite these long-entrenched attitudes, there is a small group of Japanese equity investors forming, but these tend to purchase US equities rather than equities in domestic companies. This sends out the wrong message to foreign investors and does nothing to support market prices in Japan.
Recent Developments
Despite decades of deflation and stagnant economic growth the country may be turning a corner.
A pivotal moment came recently in March 2024 with an interest rate hike from minus 0.1% to 0-0.1%. This is the first rate rise since 2007 and is a big game changer.
Since 2016 the Bank of Japan (BOJ) has been pursuing an ultra-loose monetary policy by keeping interest rates in negative territory. Now this is being normalised in response to a return to sustained inflation, albeit at very low levels.
Another highly significant development was a recent wage agreement increase of 5.28%, agreed with large Japanese companies — the largest since 1991. The big question is whether this will spill over into the broader economy, increase consumer spending and boost further economic growth. Furthermore, as inflation rises will this force savers out of low-return accounts into higher-yielding assets such as equities and bonds?
Also feeding the paradigm-change narrative is the recent surge in the Japanese equity markets, which took place in February of 2024. This was on the back of a global equities rally driven by Nvidia in the United States, and saw the last market peak made in 1989 taken out and surpassed. This is significant.
It is often postulated that financial equity markets are a leading indicator for the future health of the real economy, and this was borne out by the rebound in US markets after the financial crisis of 2009.
However, in the case of Japan, some analysts sound a cautious approach and think the markets might be getting too far ahead of the real economy.
Fiscal and Monetary Policy
The authorities, consisting of the government and the BOJ, have been actively working to improve economic conditions for decades and remain very supportive of financial markets.
Abenomic economic reforms (coined after a previous Japanese prime minister Shinzo Abe) and improved corporate governance standards have now been locked in as structural improvements. This promotes higher levels of confidence among investors and the general population.
Over the last ten years, the BOJ have been very supportive of financial markets by purchasing shares of domestic exchange traded funds (ETFs) to keep upward pressure on prices. This support looks set to continue.
The hope is that inflation has returned permanently, but it has a long way to go to achieve the BOJ target of 2%. A key stimulant towards this objective is further wage growth and inflationary pressures in the services sector.
A important consideration for foreign investors is the current weakness of the Japanese currency — the Yen. It is currently at an historic 34-year-low and trading at 155 Yen to one US dollar, which allows for the purchase of quality Japanese assets at historically low prices. Even if asset returns prove to be modest over time, the overall investment return will be boosted significantly if the currency strengthens.
Demographics
Of particular concern are the demographic trends at play in Japanese society, and the impact this may have on future economic growth and investment returns.
With a population of 124 million, Japan is the leading nation in the developed world for population decline which is happening at an average rate of 100 persons per hour. With an aging population, low fertility rate and smaller families, the labour force may lack the sheer youthful numbers to fuel the desired levels of future economic expansion and prosperity.
Summary
Overall, there would appear to be a favourable thesis for investing in Japanese assets at the current time — although some concerns linger.
On the positive side there is: i) a return to inflation (albeit at low levels), ii) a stock market making historic new highs, iii) a supportive government and central bank, iv) a low and very attractive entry-level foreign exchange rate, and v) structural economic reforms which are now fully embedded.
However, on the negative side there are: i) unfavourable demographics, and ii) an entrenched savings/risk-averse investment culture which may prove very difficult to break.
As mentioned earlier, no one has a crystal ball and any form of investment analysis (fundamental, technical or otherwise) can never predict future outcomes. We can only hope to source the quality information needed to make an informed decision.
It will be interesting to see if the land of the rising sun develops real momentum, and moves towards a more vibrant economy and profitable investment environment.
Economy Inflation Stock Market Money Business Investing Japan Equities
