Spring is special in Japan. The blossom of cherry and plum trees invites viewings – or “hanami” – across the country. The tradition speaks to the country’s appreciation of nature and the passing of seasons. But as the Japanese economy picks up momentum, will this rebound prove as ephemeral as the spring cherry blossom?
For the first time in a while, Japan has much to shout about. There has been good news from the domestic economy, including the re-election of Prime Minster Shinzo Abe and strong economic data, but also supportive global factors, particularly the low oil price and the US-led recovery. Let’s look at the issues.
Oil and wages
The large fall in the oil price since last summer has significantly lowered costs for businesses and boosted incomes, as Japan is a large net oil-importer. On the other hand, the oil price fall may entrench the deflationary mind-set, historically a problem in Japan. What could change that is a pick-up in wages.
Japan’s retirement squeeze has encouraged many women back into the labour force and kept unemployment firmly anchored. In March, Toyota and Nissan agreed to raise basic wages by about 3 per cent this year, the largest annual increase in a decade. If others follow, the current upswing in spending may last. Part of Prime Minister Abe’s carrot-and-stick approach is a phased reduction in corporate taxes, which may have mixed results as only three-in-10 companies actually pay corporate tax.
Too much cash
Many companies are having trouble growing profits, evident from the corporate sector’s growing cash pile. Hoarding appears to be a reaction to the last crisis, as deleveraging from the bubble years took over a decade. Compounding this problem is a lack of attractive domestic investment opportunities.
Top(ix) of the class
The Nikkei is at its highest since April 2000. Japanese equities have outpaced other major markets this year in dollar terms. The rally stems in part from the weak yen’s boost to exporters but also the translation effect on foreign earnings. The yen has actually strengthened a little this year against most currencies.
Meanwhile, the Government Pension Investment Fund has committed to buying equities in bulk. Yet for investors with patience the more exciting development is that, slowly, companies are open to buybacks or raising dividends. The push is coming both from inside Japan and outside. We welcome any move that leads to greater corporate responsiveness to shareholder interests.
Comply or explain
Although we have no fixed view on “Abenomics” itself, our interests converge with his. Abe is pressing hard for companies to set targets for returns, to take on more non-executive directors and to adopt transparency. Persuasion, not force, appears to be his weapon of choice. Thus, the new codes are not binding but rest on “comply or explain” terms for companies to follow. Also recommended are a greater proportion of external directors on boards.
Governance is gaining ground
Historically, Japan has not prioritised corporate governance and shareholder rights, a stance that is becoming less acceptable. The percentage of companies with at least one outsider on the board of directors increased to over 70 per cent last year, from around 45 per cent in 2008. High profile scandals (e.g. Olympus) have had an effect. However, the changes have been as much due to the new Stewardship and Corporate Governance codes. The latter follows the practice in Western jurisdictions of ensuring companies meet minimum standards. One hot topic is cash. More Japanese institutional investors are voicing their discontent with dividend policies, which has led to more engagement with management. The latest prime ministerial thrust is to make companies produce better returns.
The best companies are adaptable
We generally prefer companies with proper business models, sound balance sheets and an ability to execute. Of course, we have holdings where the pace of change could be faster and where shareholder engagement is poor, even though the company might appear to be doing the right things. What these holdings have in common is a proven ability to adapt, whether to changes at home or abroad.
Cheaper than other markets
Japanese equity valuations today are still inexpensive on an absolute basis: the Topix index is trading below its seven-year average on forward price-to-earnings. US and European stocks are dear by comparison. True, Japanese companies are generally not investing enough, reflecting the poor state of domestic demand. Instead, Japanese companies have reduced debt. The problem, therefore, is too much corporate cash and too few investment opportunities. If Abenomics comes good, clearly that could change. Even if it does not, we think Japan is past its prolonged state of “muddle through”.
So, while the cherry blossom is replete with symbolism, it is the green shoots of recovery elsewhere in the world that will lift the country. As it is, there are plenty of Japanese companies doing just fine.
Hugh Young is head of Asia Pacific equities at Aberdeen Asset Management