Japan’s transformation: A new dawn in the land of the rising sun?
After more than 30 years, Japan is once again forcing itself upon the attention of international investors.
In a fragile world, the world’s third-largest economy is generating solid economic growth and strong corporate profits. Deflation appears to have been vanquished and animal spirits are in the air: the stock market reached a 33-year high in late November, surpassing the peak reached during the 1980s bubble.
A degree of skepticism remains, of course, and rightly so. Previous efforts at renewal have petered out and so have positive returns and investor enthusiasm. But this time is different, argues Tsutomu Saito, Multi Asset Strategist at Societe Generale Securities Japan Limited: “I believe the change is genuine this time. A new Japan is emerging, with inflation returning and structural reforms accelerating.”
I believe the change is genuine this time. A new Japan is emerging, with inflation returning and structural reforms accelerating.
The latter are a key reason for the current optimism. Building on the efforts of previous administrations, the government of Prime Minister Fumio Kishida is unleashing the so-called ‘third arrow’ of Abenomics, the economic policy initiated by late premier Shinzo Abe. On top of continued easy monetary policy and repeated infusions of fiscal stimulus, it is finally tackling some of the country’s structural rigidities.
Focus on labour market and energy transition
This is most obvious in the labour market, where encouraging older employees and women into the job market and attacking an entrenched seniority-based pay and promotion system has lifted the work force participation rate for those aged 15-64 to 81.6% as of September – the highest it has ever been. Meanwhile, average monthly wage growth reached 3% earlier this year and remains healthily positive, a major factor in the country’s escape from years of falling prices. This is underpinned by a ratio of 1.3 job openings per applicant – ironically, Japan’s challenging demographics, the cause of much national handwringing, are a positive factor in re-embedding inflation into the economy.
The government is also tackling the energy transition with gusto – and cash. Its Green Transformation (GX) policy promises Y150 trillion ($1 trillion) over 10 years in public and private money to accelerate national efforts at decarbonisation. While this programme appears much smaller than the US Inflation Reduction Act or Europe’s REPowerEU initiative, Mr Saito points out that Japan is also generously subsidizing moves to enhance energy security and to build green supply chains in the country.
Per capita, therefore, Japan’s GX stimulus is more significant than the headline figure suggests. Moreover, the country is a leader in developing advanced cleantech, focusing on hydrogen and ammonia as both fuels and storage vectors, as well as carbon capture.
Beyond these two signature policies, the administration is expanding its NISA tax free savings scheme in January, to encourage individuals to invest more of their significant cash savings in equities. It has also launched efforts to attract international asset managers and to digitalise the country’s notoriously paper-based bureaucracy.
Bottom-up reforms are also accelerating. The corporate governance code promulgated by Abe almost a decade ago has been reinforced by recent regulations from the Japan Stock Exchange, which requires publicly listed companies to increase their price/book value above one or be demoted to a lower tier of the stock market.
This has triggered a wave of share buybacks, as managements have unlocked cash cushions built up during the pandemic, with last year setting a record at Y9.4 trillion and 2023 coming close, with more than Y8.8 trillion announced to date. Companies are also, at last, increasing wages consistently in an effort to attract and retain workers and reallocating capital and staff away from less profitable business units.
Japan is not about to see the volume of spin-offs and sales to private equity common in the west, partly for cultural reasons but also because changing employment contracts and laying off staff is so complex and expensive. Intriguingly, Mr Saito says that METI, the Industry Ministry, is considering reducing the tax and administrative burdens blocking such restructurings.
Meanwhile, younger people are already making different choices. The dream job for graduates of Todai, the top-ranked Tokyo University, is no longer a government ministry or joining a large multi-national. Instead, they are choosing to start their own companies based on their university research, becoming software engineers, working in biotechnology or for environmental companies. It is hard to overestimate this shift in a country that is as traditional and socially conservative as Japan.
Returning appetite for risk
Mr Saito notes that while its reputation belies this, the appetite for risk that drove national economic development a generation ago is returning – reflected in the entrepreneurial drive of younger workers; in the growth in private investment and corporate productivity; and in the gradual return of consumer confidence. “Wage growth is really fundamental in increasing consumer confidence,” he says. “And this is enabling people to cope with higher prices. As long as quality is improving, Japanese people don’t mind paying a bit more.”
For international investors, the question is whether all this has already been priced in given a 30% or so rise in Japanese equities this year? By no means, argues Mr Saito. If a national revival is genuinely underway, then corporate earnings should continue to grow healthily for years. At the same time, there is room for multiple expansion given Japan’s discount to the US, as well as improving earnings quality as companies become more shareholder friendly. Japan has transformed itself throughout its history and looks to be doing so once again.