July 2015
Schroders
Talking Point
Japanese equities: Looking beyond the
recent highs
Andrew Rose, Fund Manager, Japanese Equities
Earlier headlines in Japan have been dominated by a flurry of multi-year stock market highs and
currency levels being hit. Digging a little deeper, though, we still find plenty of reasons to remain
positive.
Recently, the market capitalisation of the Japanese stock market has hit its highest ever level while the
Japanese yen has sunk to a 12-year low versus the dollar. In 2000, shortly after the Nikkei topped 20,000, it
then proceeded to drop by two-thirds over the following two years. How different are conditions for Japanese
equities now? How can the weak yen help the stock market?
Encouraging corporate outlook
Although the question is broad, from a valuations perspective at least, the picture is brighter. The aggregate
price-to-earnings ratio (PER) today is around one-third or half of its 1989 and 2000 levels, respectively.
Furthermore, the comparisons for the price-to-book (PB) ratio are one-fifth and half. In terms of companies’
Return-on-Equity (RoE), average RoEs today are about double what they were in 2000.
This is an encouraging sign of the relatively more salubrious condition of corporate Japan in 2015. Even
though this, less fortuitously, also marks a return to the RoE levels of the market in 1989, just before the crash,
a closer look at the data does provide some comfort. Balance sheet gearing was higher in 1989 while the
quality of earnings today is higher, either through more reliable accounting procedures or less of a reliance on
non-recurring financial market profits.
Better governance yielding dividends
Back in both 1989 and 2000, the dividend yield of the market offered little downside protection given its low
absolute level (sub-1%). However, in the current market yields are higher and the potential for payouts to grow
is also more promising as a superior profits outlook has allowed management to be more generous in paying
out dividends.
Measures to raise shareholder awareness and improve corporate governance of Japanese companies have
also helped. The introduction of a Corporate Governance Code has brought about generally more positive
corporate behaviour from management, such as the setting of RoE targets and an increase in share buybacks.
The adoption of a Japanese Stewardship Code last year, which aims to ensure institutional investors are more
transparent on how they vote at AGMs while also engaging more actively with company management, should
also help to drive a longer-term sustainable growth in the corporate sector.
Improved prospects for the economy
SchrodersTalking Point
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Despite the anaemic growth recovery of Japan’s economy, following its exit from recession in the last quarter
of 2014, the outlook is significantly brighter on the back of lower oil prices. A weaker yen has helped
manufacturing climb out of its slump, with industrial production and exports numbers starting to show a gradual
improvement.
Policy is also supportive. The widely-recognised ‘three arrows’ of Abenomics are in action, with the first two
arrows of monetary easing and fiscal stimulus. The Bank of Japan (BoJ) has continued to add government
bonds to its balance sheet while flexible fiscal policy has relieved downward pressures on the economy. A
postponement until April 2017 of the second consumption tax rate hike and supplementary budget measures
to help support families and SMEs are some of the more positive moves by the authorities. Meanwhile,
unemployment remains at multi-year lows with the labour market remaining tight. Real income growth is also
set to turn positive as wages pick up.
Cautiously optimistic
Overall, trends are generally positive for the corporate sector in Japan, as profits and shareholder returns both
continue to expand. Indeed, there is also room to improve areas of corporate governance but the current
measures in place are ensuring this transition, albeit long-term, will further strengthen the investment case for
Japanese companies.
An uptick in the allocation of the GPIF – the world’s largest pension fund – to Japanese equities is also having
a positive effect on the stock market. Although investors should be aware of potential risks over the short- to
medium-term, such as possible economic disappointment or geo-political worries related to China, the
long-term case for investing in Japanese companies is relatively bright.
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