Japan Equities in the New Era
The 30-year Heisei era has often been associated with the lost two decades, a period between 1992 and 2012 when nominal growth stagnated at around JPY500tn and the equity markets remained well below their end-1989 historical peak. Unlike the lost two decades, the new Reiwa era starts with nominal growth rising above the JGB yield, a sign that the economy is reflating.
The era also starts with a lower valuation. A price regime shift, from protracted deflation to (albeit muted) inflation should reflect in a higher valuation. This has not yet been the case. Japanese equities are currently trading at a lower valuation than at the start of Abenomics in early 2013. In fact, the more than doubling of the equity market is entirely due to a jump in earnings. Today, among the Topix 500 companies, more than a third of components still trade below their book value.
Finally, the corporate governance framework has been reformed. Following the introduction of three major pieces of regulation (the stewardship code, the revision of the Companies Act and the governance code), the Japan Life Insurance Association corporate survey notes a marked increase in the percentage of companies that have set ROE and shareholder return targets; banks have been unwinding cross-shareholdings at an accelerated pace, and total shareholder yield has improved. The next step in regulatory reform is likely to come from the Japan Exchange (JPX) and form part of the government growth strategy blueprint to be released in June.
The end of deflation, undemanding equity valuations and corporate governance progress should all be powerful drivers of long-term equity performance. However, with the exception of the Bank of Japan and corporates, there are no equity buyers. In fact, foreign investors have sold equities at an unprecedented level since 2018. Perhaps, they find better investment opportunities elsewhere: in the last 16 months outflows have been almost equal to inflows into Chinese equities. The risk of the yen appreciating and re-correlating negatively with equities is also a deterrent. But more importantly the market is generally concerned the risk of a consumption tax hike, planned for 1 October this year.
The Japanese Foreign Ministry has translated “Reiwa” as “Beautiful Harmony”. For equity investors, the tax policy threatens this harmony. It also creates investment opportunities.
Access the latest Asia Cross Asset Focus report, Japan Equities: Welcome to a New Era, the bank’s equity strategist for the full picture.
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