Welcome to Japan

“If we don’t take our time, it’s not wise.”

The Strokes, Welcome to Japan, Comedown Machine (2013)

Japanese equities are back! It’s only taken – checks notes – 33 years for the Topix to recover from the late 1980s bubble and with the index up 13.4% year-to-date, outperforming most major indices, it’s no surprise that we’ve seen a lot of interest in Japan recently. I mean, if it’s good enough for Warren…?

But what’s been driving the rally? Well for one thing, it's clear that the cost of capital is once again dictating returns. Japan has endured a decade of negative interest rates, with the Bank of Japan exerting a stranglehold on the long end of the yield curve. And it’s not like that pivot is going to be easy for new Bank of Japan governor Kazuo Ueda. We’re talking about a massively increased balance sheet that is filled with (amongst other things) locally listed ETFs and Japanese real estate investment trusts. “Handle with care” is likely to be stamped on every policy announcement from here on out but, for now, with real rates rising, capital intensive sectors are once again flourishing – to the benefit of the Topix as a whole.

Putting that in context, Japan is a notoriously ‘old economy’ equity market, weighted towards machinery, autos and domestic consumers. In an environment like this, it’s precisely those sectors which have benefitted the most, with the subindices up 25.7% and 15.6% respectively since the start of the year.?

It’s here where I turn to my colleagues in Man GLG who are undoubtedly our resident experts on the subject. Firstly, on that line in red on the chart above, it’s no secret that while traditional sectors have rallied, financials have a had an especially difficult time of it. But is the wider ‘banks are bad’ kneejerk reaction creating a contrarian opportunity? Looking at the valuations, Japanese banks trade at 0.55x against US banks on nearly 0.9x. As the BoJ raises rates, I think bank profitability makes a pretty compelling case here.

Speaking of valuations, this brings us to perhaps the most ground-breaking, era defining changes to corporate governance to hit the Japanese equity landscape in decades: a minor footnote in a recent announcement from the Tokyo Stock Exchange...

Okay, hyperbole aside, these changes are likely to be significant and – for our purposes here – give a good indication as to why investors believe that this time is different for Japan.

Long story short, the TSE is promising to take companies which trade below book value to task. They’ll need to come up with capital improvement plans and ‘require that management and the board of directors properly identify the company’s cost of capital and capital efficiency’. For Japan, this is pretty huge! We’re talking about a market where over half of the entire index trades below book value.

For context, 3% of the S&P trades below 1.0x…

And we’re already starting to see this take effect. Increasing share buybacks is one of the easiest levers for an executive to pull to improve capital policy and wouldn’t you know it, the number of buyback announcements in Japan in 2022 hit a new record.

Or, as my Man GLG colleagues put it:

“In no other major developed market would it be possible for investors to make large returns by simply making an AGM proposal that requests a dividend hike or share buybacks.”

The Japanese economy may be old fashioned. It may trade so cheaply that it boggles the mind. But for many investors, Japanese stocks are in the right place, at the right time, and corporate management may be about to be doing the right things.?