The Changing Game of the Yen. Adapting Our Strategies in Japan

We shifted from an Overweight Unhedged position to an Overweight Hedged strategy.

Investing in the Yen today is like following an instruction manual where the pages are shuffled with every turn. Japanese authorities have made it increasingly precarious, akin to rowing a canoe near a waterfall.

To grasp the complexity of investing in this market: during the first week of August, Shigeru Ishiba, then a candidate for Prime Minister (now already in office), openly supported the normalization of BOJ policy, namely interest rate hikes. This occurred in a context where the BOJ had just raised interest rates on July 30, fully aware that this stance would exacerbate expectations for further hikes. Indeed, this happened, leading the JPY to appreciate by 16% against the USD (from 162 to 140). At the time, we maintained a long position in Japan with no currency hedge (unhedged) and a price target for the Yen of 130-135, expecting an additional 6% appreciation. We decided to maintain our Yen position, reassured by Ishiba’s long-standing critical stance toward the monetary stimulus spearheaded by former BOJ governor Haruhiko Kuroda.

Unfortunately, once Ishiba became Prime Minister, his stance quickly faded—faster than a commitment to a diet in front of a five-star buffet. The new authorities have abruptly abandoned the nascent monetary normalization process observed in July and reverted to the characteristic ambiguity of gradualism and procrastination in stimulus withdrawal. A return to the stance that previously led to a sharp depreciation of the JPY. The so-called "Yen PUT" has proven short-lived. We fear that both the new government and the BOJ, in their executive role, will allow the JPY to resume its path of depreciation. Our concerns are based on recent examples of this new, more relaxed approach to exchange rate policy, as evidenced by the remarks of the newly appointed Finance Minister Kato, who recently stated that "a weak yen has both advantages and disadvantages." The fact that the minister suggests that a weak JPY has "advantages" signals that the authorities are comfortable seeing a return to Yen depreciation. Similarly, BOJ board member Asahi Noguchi emphasized the need for a gradual tone in the bank’s key message. "There is room for a bit more adjustment, but we will assess each rate hike and take the next step when it is safe to do so." Clearly, a slow approach to interest rate normalization—far from the expectations of July.

In conclusion, the new political approach is negative for the JPY but, at the same time, positive for the Japanese equity market. That is why we decided to adjust our strategy for the Japanese market yesterday, shifting from an Overweight Unhedged position to an Overweight Hedged one.

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Why Overweight the Japanese Equity Market?

Governance reforms have only just begun. These are not my words, but those of the head of the Tokyo Stock Exchange (TSE). Our expectations are high that the Japanese stock market will see a positive re-rating as corporate managers become increasingly aware of the necessity of engaging with shareholders. We have identified progress among TSE Prime constituents in their strategies to improve stock performance, although the regulator continues to urge companies to regularly engage with shareholders.

It is important to remember that all these governance reforms are part of a broader process in which the TSE is pressing CEOs to improve capital efficiency metrics and share prices. Gradually, more top-tier Japanese companies are committing to enhancing stock prices and shareholder returns. This stems from a singularity, an anomaly: approximately 47% of companies in Japan's broad Topix index were trading below book value in Q1 2024, compared to 18.4% in Europe and 4.8% in the US (according to data from Jefferies). This anomaly persists today, suggesting that Japanese companies tend to hold excess cash and other assets, such as shares in other companies, rather than using them to improve shareholder returns.

In this context, the TSE is promoting a mandatory reform requiring companies to acknowledge this problem of low P/BV ratios. They are urged to publish the causes of their low ratios (mainly related to excessively complex and inefficient capital structures) and the measures to be taken to raise their stock prices. The TSE's move is bold, the latest in a series of reforms aimed at increasing the attractiveness of the Japanese stock market for investors. Companies have begun to respond to these reforms, with share buybacks reaching a record high last May, and greater transparency and promotion of changes in capital structures to meet regulatory objectives. Therefore, we are maintaining our position in the Japanese market within our mandates. Especially now that we have seen how long it will take for stimulus measures to be fully withdrawn.

Sincerely,

Alex FUSTE

Chief Global Economist

ANDBANK