FROM THE LOST DECADES TO FOUND
OPPORTUNITIES: JAPAN'S
RESURGENT ECONOMY AND
FLOURISHING STOCK MARKET
RESEARCH REPORT FOR JULY 2023
Analysts: Sagar Bar, Ignacio Paz, Alfonso Sepúlveda, Devya Goenka
SORA CAPITAL
info.soracapital@gmail.com
"THERE ARE FOUR TYPES OF
ECONOMIES IN THE WORLD:
DEVELOPED ECONOMIES,
UNDEVELOPED ECONOMIES, JAPAN
AND ARGENTINA".
– SIMON KUZNETS
2
INDEX:
11
Economy Snapshot
2
The Yen
3
The Japanese Stock Market
1
1
3
Economic Snapshot
By Sagar Bar, Market Analyst
4
Economic Profile of Japan
Japan, an East Asian nation with a highly developed social market economy, holds a prominent position
in the global economic landscape. As of 2023, it ranks as the third-largest economy in the world by
nominal GDP and the fourth largest by purchasing power parity (PPP). Additionally, it stands as the
second-largest developed economy globally. Japan is a member of both the G7 and G20, contributing to
its influential role in shaping international economic policies.
(I)
GDP and Economic Indicators: Japan's per capita GDP (PPP) reached $51,809 in 2023,
reflecting its prosperity and high living standards. However, the Japanese economy is
influenced by volatile currency exchange rates, leading to sharp fluctuations in its GDP when
measured in dollars. The quarterly Tankan survey, conducted by the Bank of Japan, provides
a key indicator of business sentiment and economic prospects.
(II)
Stock Market and Trade: The Japan Exchange Group operates the Nikkei 225, which offers
monthly reports on top blue-chip equities. The stock exchange ranks as the world's fifth largest
by market capitalization. Japan was the world's fourth-largest importer and exporter in 2018,
indicating its significant role in global trade. The country boasts the world's second-largest
foreign-exchange reserves, valued at $1.4 trillion, which contribute to its economic stability.
(III)
Competitiveness and Innovation: According to the Global Competitiveness Report, Japan
ranks fifth globally, showcasing its ability to foster a competitive business environment. The
nation's economic complexity index also places it at the forefront of nations with advanced and
diverse economies. Japan stands out as one of the world's most innovative countries, evident
from its leading position in global patent filings.
(IV)
Manufacturing and Industrial Clusters: Japan is the world's second-largest automobile
manufacturing country, with a strong emphasis on high-tech and precision goods like
integrated circuits, hybrid vehicles, and robotics. The Kantō and Kansai regions serve as major
industrial clusters and manufacturing centres, driving economic growth and technological
advancements.
(V)
Financial Strength and Creditor Nation: Japan holds the title of the world's largest creditor
nation, signifying its substantial lending and financial influence globally. The country
consistently maintains an annual trade surplus and possesses a considerable net international
investment surplus. As of 2020, Japan's financial assets amount to $12 trillion, accounting for
8.6% of the global GDP total, demonstrating its robust financial position.
(VI)
Fortune Global 500 Companies and Total Wealth: As of 2022, 47 of the Fortune Global 500
companies are headquartered in Japan, attesting to the country's prominence in the corporate
world. Additionally, Japan ranks third in the world by total wealth, showcasing the nation's
overall economic strength.
5
Report Section Structure
This section of the report aims to provide the economic context to the report’s overarching theme which
is the Japanese stock market. Furthermore, this section will identify historic drivers of growth and explain
future economic catalyst for Japan in light of the increased attention the nation has received from
institutional investors recently.
Japan’s GDP Trends
Real GDP, LCU ($B)
Real GDP Growth (%)
7,000.00
8.00
6,000.00
6.00
5,000.00
4.00
2.00
4,000.00
0.00
3,000.00
(2.00)
2,000.00
(4.00)
1,000.00
(6.00)
0.00
(8.00)
Source: Bloomberg
Analysis of GDP Trends
From the data above, we can see that Japan's GDP has fluctuated over the years. There have been
periods of robust growth, such as in the late 1980s and early 1990s, followed by a slowdown in the mid1990s. The economy experienced steady growth in the early 2000s, followed by a contraction during the
global financial crisis in 2008-2009. After that, there were periods of moderate growth and occasional
contractions, indicating economic volatility.
Japan’s Post War Economic Miracle
1. Recovery Stage (1946–1954): After the devastation of World War II, Japan's economy was in
ruins. However, with support from the United States and successful economic reforms, Japan
managed to recover and rebuild its industrial capacity. The government's focus on heavy
industrialization and technological advancements contributed to this stage of growth.
2. High-Increasing Stage (1955–1972): During this period, Japan experienced rapid economic
growth and became the first developed nation in East Asia. The government implemented policies
to stimulate domestic demand and promote exports. The formation of keiretsu (business
conglomerates) and trade liberalisation played significant roles in the country's expansion.
6
3. Steady-Increasing Stage (1973–1992): The oil crises in the 1970s presented challenges to
Japan's economy. However, the country transformed its production focus from productconcentrating to technology-concentrating. Japan's ability to adapt and focus on technologyintensive industries contributed to its steady economic growth during this stage.
Overall, Japan's economic miracle was characterized by strategic government policies, technological
advancements, export-driven growth, and the development of keiretsu conglomerates. The stages of
recovery, high increase, and steady increase marked different phases of growth and transformation,
leading Japan to become the third-largest economy in the world by the 1960s. However, challenges in
the 1980s, including a bubble economy and international tensions, had an impact on the subsequent
growth rate in the 1990s and beyond.
Source: Tetsuji, 2023
Japan’s GDP Forecasts
4,200.00
1.20
y = 35.834x + 3906.3
1.06
4,150.00
0.98
1.01
4,100.00
1.00
0.87
4,050.00
0.81
0.81
0.84
4,000.00
0.80
0.60
3,950.00
0.40
3,900.00
0.20
3,850.00
3,800.00
0.00
2024 E
2025 E
Real GDP, LCU ($B)
2026 E
2027 E
Real GDP Growth (%)
2028 E
2029 E
2030 E
Linear (Real GDP, LCU ($B))
7
Based on Figure 1, Japan's real GDP growth rate is currently hovering around 1.2% to 1.3%. By utilising
the consensus growth rates from Capital IQ, Figure 3 has forecasted that the nation's real GDP will reach
FY2030. According to the regression model, the country's GDP is projected to increase by an average
of $35 billion annually. While FY2024 to FY2026 have mostly followed the growth trend, this level is
expected to slow down and fall below the trend level with a projected increase of 0.81%.
To access factors impacting the trend level growth of Japan a more granular view of Real GDP is
required; hence the next section of the report aims to analyse the composition of GDP and structural
factors affecting Japan’s growth.
Japan’s GDP Composition
Source: (Micromicron, 2022)
Japan's Gross Domestic Product (GDP) composition for the year 2021 reveals valuable insights into the
nation's economic activity and the factors driving its growth. Consumption, a significant contributor,
accounted for 53.51% of the GDP, highlighting the strength of domestic demand and consumer spending
in the Japanese economy. This indicates a positive outlook for businesses as consumers continue to fuel
economic growth through their purchasing power.
Another crucial component is Capital Formation, also known as investment, which made up 25.60% of
Japan's GDP in 2021. This reflects the extent of investments made by businesses in expanding their
operations and upgrading infrastructure, indicating a favourable business environment and confidence
in the country's economic prospects. Investment plays a pivotal role in driving productivity and long-term
economic expansion.
Japan's Government Expenditure constituted 21.43% of the GDP in 2021, highlighting the government's
role in stimulating economic growth through public spending. This indicates a commitment to
infrastructure development, public services, and other initiatives aimed at supporting various sectors of
the economy. Government expenditure can have a significant impact on economic growth and stability,
making it a crucial aspect to monitor.
8
The performance of Japan's trade sector is also evident from the figures on Exports and Imports. In 2021,
Exports contributed 18.20% to the GDP, signifying the nation's ability to compete globally and its success
in international markets. On the other hand, Imports accounted for 18.74% of the GDP, indicating that
Japan was running a trade deficit during that year. A trade deficit means that the value of imports exceeds
the value of exports, and it can impact a country's overall economic performance.
Japan’s GDP Composition Trends
This section of the report will focus on more granular trends in private consumption, government
consumption, fixed investment, and Industrial Production. (All sources: Capital IQ)
Private Consumption
Real Private Consumption Growth (%)
6.00 %
4.00 %
2.00 %
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
0.00 %
% (2.00)
% (4.00)
% (6.00)
Source: Capital IQ
Real Gross Fixed Investments
Real Gross Fixed Investment Growth (%)
Real Gross Fixed Investment, LCU ($B)
15.00
1,800.00
1,600.00
10.00
1,400.00
5.00
1,200.00
1,000.00
0.00
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
(5.00)
800.00
600.00
400.00
(10.00)
200.00
(15.00)
0.00
9
(0.50)
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
(5.00)
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
Industrial Production
Industrial Production Growth (%)
20.00
15.00
10.00
5.00
0.00
(10.00)
(15.00)
(20.00)
(25.00)
Government Consumption
Real Government Consumption Growth (%)
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
10
Tarde by nation (Countries/Region Trade Activity – Last 2 Years)
Japan Demographics
Population Trends
130.00
0.60
y = -0.0262x + 0.503
128.00
0.40
126.00
0.20
124.00
0.00
122.00
(0.20)
120.00
(0.40)
118.00
(0.60)
116.00
(0.80)
2026 E
2025 E
2024 E
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
Population (M)
Population Growth (%)
Linear (Population Growth (%))
11
The population of Japan has exhibited a gradual increase over the years, although this growth has been
accompanied by a notable decline in the population growth rate. From 1988 to 2010, the population
steadily rose from 122 million to 128 million. However, post-2010, there has been a noticeable slowdown
in population growth.
Furthermore, a regression analysis of the data indicates that the average population growth rate over the
given time period has been declining at a rate of approximately -0.026%. This suggests that Japan is
experiencing a demographic shift, with the growth rate gradually decreasing, which is a significant trend
for the country's future. Some of the implications of the ageing population are listed below:
•
Aging Population: Japan is facing an aging population, with a significant proportion of its citizens
being elderly. This demographic shift poses challenges for the country's social security system
and healthcare expenditures as the demand for elderly care and medical services increases.
•
Labour Force Shortage: The declining and aging population results in a shrinking labour force,
which can lead to labour shortages in various industries. A smaller workforce can potentially
hamper economic productivity and growth.
•
Increased Dependency Ratio: As the proportion of elderly people increases in the population,
the dependency ratio (the number of dependents to the working-age population) rises. This puts
pressure on the working-age population to support a larger elderly population, impacting public
spending and welfare programs.
•
Consumer Patterns: With an aging population, consumer patterns may change, with a higher
demand for healthcare services, pension plans, and other products and services catering to the
elderly.
12
Risk and Opportunity Assessment of the
Japanese Economy
Economic Growth in 2022
Japan's economic growth in 2022 slowed compared to 2021 due to multiple factors, including high
commodity prices, supply-side constraints, and the lingering effects of the Covid-19 pandemic. While
private consumption and gross investment showed stronger recovery in the second half of the year, net
exports became a drag on growth due to high import prices, reduced tourism receipts, and a global trade
slowdown. As a result, Japan's trade deficit in 2022 reached the largest level in over 40 years, amounting
to JPY 19.97 trillion.
Resilient Domestic Demand in 2023
Despite the global economic slowdown, Japan's domestic demand is expected to display resilience in
2023. The momentum from reopening the economy will boost household consumption as consumer
cautiousness fades. Additionally, positive real wage growth, anticipated following spring wage
negotiations, along with a reduction in excess household savings, will provide further support to
consumer spending. Strong momentum in capital expenditure (capex) is also expected to bolster the
Japanese economy. Corporate firms have already increased capex significantly, and the trend is likely
to continue in 2023, driven by demand for sustainability, digital transformation, and solutions for
alleviating manpower shortages.
Challenges in Industrial Production and External Demand
Easing supply bottlenecks are expected to support the recovery in industrial production, although the
auto sector may continue to face disruptions in component supply, limiting output. On the other hand,
waning external demand poses a significant headwind to Japan's GDP growth. While Japan's exports
grew by 18% year-on-year in 2022, comparable to the rise seen in 2021, the gradual normalization of
supply chains played a role in this growth.
Widening Trade Deficit and Current Account Surplus
The combination of weaker goods export performance and robust domestic demand may lead to a wider
trade deficit. However, Japan's current account balance is expected to remain in surplus, as the trade
deficit will be more than offset by a primary income surplus, reflecting strong income receipts from
Japan's overseas portfolio investment assets. The country's net international investment position (NIIP)
has been rising due to outward foreign direct investment (FDI) and portfolio outflows.
13
Widening Trade Deficit
1,200.00
1,000.00
800.00
600.00
400.00
200.00
0.00
2026 E
2025 E
2024 E
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
(200.00)
Trade Balance ($B)
Goods Exports ($B)
Goods Imports ($B)
Source: Capital IQ
Net Capital Flows
300.00
200.00
100.00
0.00
2026 E
2025 E
2024 E
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
(100.00)
(200.00)
Direct Investment Balance ($B)
(300.00)
Inward Direct Investment ($B)
Outward Direct Investment ($B)
Source: Capital IQ
Fiscal Challenges and Public Spending
Japan's fiscal situation faces challenges as combined budget requests for FY23 have increased to JPY
114.4 trillion (20% of GDP), up 6% from FY22's JPY 107.6 trillion (19.1% of GDP). Debt-servicing and
social security spending constitute significant portions of the budget. Notably, Japan plans to hike its
defence budget by over a quarter to JPY 6.8 trillion (1.2% of GDP) to address rising security challenges.
14
The government's routine posting of extra budgets each year is likely to undermine fiscal consolidation
efforts, and continued government borrowings may push the level of outstanding long-term debt to JPY
1,279 trillion (USD 10 trillion), about 224% of Japan's GDP.
Public Debt/GDP (%)
Public Debt/GDP (%)
300.00
250.00
200.00
150.00
100.00
50.00
0.00
2026 E
2024 E
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
Debt v.s. Bond Yield
20,000.00
10.00
18,000.00
5.00
16,000.00
14,000.00
0.00
12,000.00
10,000.00
(5.00)
8,000.00
(10.00)
6,000.00
4,000.00
(15.00)
2,000.00
0.00
(20.00)
Interest Payments ($B)
Interest Payment Growth Rate (%)
15
Based on the last chart, it is a good sign that Japan's high level of debt is being positively affected by
the decreasing level of debt interest payments as a percentage of GDP. Additionally, Japan's QE has
managed to keep yields at a very low level, which has made debt financing much more affordable for
Japan when looking at historical data.
However, there is a potential risk in the form of Japan's recent high inflation levels that have surpassed
the target of 2%. This phenomenon could potentially lead to an upward trend in interest rates,
consequently resulting in higher bond yields. Consequently, this may entail an increase in interest
obligations for newly issued sovereign debt.
Source: Pixels
Monetary Policy and Inflation
The Bank of Japan's (BOJ) key inflation gauge, the core CPI (excluding fresh food), has remained above
2% since April 2022, reaching 4.1% in December 2022, the highest in over 41 years. This has prompted
the BOJ to make slight adjustments to the yield curve control (YCC) band in December. The central bank
is likely to continue its gradual path of monetary policy normalization, with potential adjustments to the
YCC and negative interest rate policy (NIRP). However, an unexpectedly rapid increase in inflation could
pose a serious risk, leading to aggressive BOJ rate hikes that may destabilize the domestic business
environment, increase government debt payment pressures, and undermine financial stability.
16
The Yen (¥)
By Alfonso Sepúlveda, Lead Portfolio Manager & Partner
17
SAFEGUARDING PRICE STABILITY
The Japanese Yen
Japan’s national currency (the Japanese Yen or JPY) has played a crucial role in its economic
development, both during its period of astounding growth that has since come to be known as the
Economic Miracle following their resounding defeat in World War II as well during its more modern
evolution in the 21st Century.
Before going over how the evolution of the Yen has marked the trajectory of the Japanese economy in
the past and how it will continue to play a critical role in its course in the years ahead, it is important to
understand one of the main determinants of a currency’s value and how it can be an important element
of a country’s exchange rate, this being inflation.
Inflation, a phenomenon that growing economies have become very familiar with, is a disease with
which Japan hasn’t been inflicted for the better part of the last half century. For developed economies
in the West, inflation often becomes priority number one for central bank officials when their respective
economies are beginning to run a little hot. Central bank officials, whose main mandate is to allow for
positive but sustainable growth of their country’s economy, have a big problem with rampant inflation
because it corrodeS the value of money and severely affects consumers’ purchasing power. Such has
been the case for growing nations for hundreds of years, as inflation is often a byproduct of cyclical
periods of economic growth.
As such, when an economy is growing steadily while unemployment figures remain low, inflation
concerns start to pop into central bank officials’ heads, as a growing economy makes for increased
consumer demand for various goods and services. When this increase in demand far exceeds the
increase in demand, prices begin to rise.
Such is the macroeconomic theory that explains both the causes and effects of inflation, and while it
largely holds for most developed nations, there is and historically has been a very notable exception,
Japan
Japan’s deflationary woes began back in 1990, the start of the infamous period that came to be known
as The Lost Decade. During this period, Japan experienced a slow and painful period of economic
stagnation (this being an economic phenomenon whereby an economy experiences slow or flat growth)
in which prices rapidly and constantly fell, resulting in falling consumption, investment and wages, and
ultimately a very deep recession that lasted longer than 10 years.
18
Japan’s Exchange Rate Regime
The value of a country’s currency plays a crucial role in the growth prospects of a nation’s economy.
The currency being the main medium by which goods and assets can be purchased, its value and
overall stability are crucial both to the overall well-being of the nation’s citizens as well as to the
country’s overall role in the international game board of trade and finance.
Price Stability
First of all, a stable currency is key to obtaining price stability in a nation. Price stability is the state of
equilibrium in which the general level of prices for goods and services remains considerably constant
over time; as well as a major and collective aspiration of all central bankers. A country where both
regular citizens and investors can expect prices to remain relatively stable for the medium to long-term
is one poised for healthy and sustainable economic growth.
Trade and globalization
Prior to Japan’s decade-long period of sluggish economic growth, the nation had experienced a
prolonged period of considerable economic growth and development. Dubbed the Japanese Economic
Miracle, this period of rapid expansion began in the 1950’s and was characterized by an astounding
growth of consumer good industries, particularly those intended to be exported to other nations that
were also experiencing periods of post-war growth and economic prosperity. Japan’s growth as an
exporting nation during this period had significant influence on the evolution of the yen, as the
increasing attractiveness of Japanese exports including blah blah blah and blah blah blah caused for
international companies and investors to purchase the Japanese currency to be able to import from
Japan’s highly competitive goods and services. This significant rise in Japanese exports did, by the
very laws of supply and demand, place significant upward pressure on the currency as more and more
entities and individuals worldwide wished to change their own local currency into that of the Japanese
And while a strong currency can have its many benefits to both the overall economics and improvement
in citizens’ living standards, it is not necessarily ideal for a country that relies heavily on exports as a
source of income. As such, for Japan’s export-driven economic boom to continue rolling past their initial
years, a stable Yen was indispensable.
The reason why a strengthening currency can debilitate a nation’s exports is driven by laws of supply
and demand. When many developed nations started viewing Japanese products as attractive and
competitive options, they had to first convert their local currency into that of Japan to be able to acquire
some of Japan’s cutting-edge products. By exchanging their local currency and getting yen in return,
When the international demand for some of these products increased, so did the demand for the yen
needed to acquire said products. When many of these developed nations started purchasing large
amounts of Yen, the currency began to experience upward pressure as demand for it greatly increased
at the astonishing pace that Japanese exports did during this same time. As a result, the Yen began to
strengthen, which paradoxically made the wide range of exports that caused its rise in value to become
less and less competitive.
The reason for this is that by indirectly strengthening the value of the yen relative to other currencies,
Japanese goods that were priced in Yen became more and more expensive for other countries to
import. In a typical free float exchange rate rate in which the currency is allowed to fluctuate according
to market forces and expectations, such rapid shifts in demand for a nation’s exports would see the
currency strengthening significantly. However, for a country that was beginning to experience a sure19
footed and dominant ascent to economic world power that relied heavily on exports, such fluctuations
presented a heavy burden.
As a result, the Bank of Japan, in its role as the agent of the Minister of Finance has since conducted
numerous foreign exchange interventions with the goal of stabilizing its exchange rates of Japanese
currency. This role of guardian of the currency is one that is quite specific to Japan’s central bank, and
something that has since made the country notorious for its frequent interventions in the FX market to
prevent excessive appreciation of its currency. In such a context was the economic miracle of Japan
marked by constant intervention to keep its 10% yearly growth export-driven economy booming. For
this very same reason of frequent foreign exchange market intervention by Japan’s minister of Finance,
the value of the Yen remained relatively stable, and more importantly, relatively low when compared to
other major currencies during this period, such as the US dollar, the British pound or the French francs,
all of these being the national currency of various economies that gravitated heavily towards Japanese
products in emergent industries, such as electronics and appliances, automobiles, consumer goods,
and even machinery and industrial equipment.
How Does This Explain the Present of the Yen
Understanding the role the Ministry of Finance and the Bank of Japan have played in the evolution of
the country’s currency and thus on the overall evolution of its exporting economy is crucial to appreciate
why the Yen trades at such low levels when compared with other dominant currencies like the Euro,
the dollar, or the pound.
For a country that, as stated and explained in detail in the previous paragraphs, relies heavily on
exports, a stable and somewhat “suppressed” currency is crucial to keep the economy afloat.
Source: World Bank
20
For this reason, Japan has continued suppressing its interest rate by selling its own currency. One of
the major ways in which the BOJ and the ministry of finance do this is with the purchase of U.S.
government debt. It is no wonder then that Japan happens to be the number 1 creditor to the United
States. Japan, by taking advantage of the ample liquidity that the U.S. government bond market
provides to deliberately suppress its exchange rate, has continuously sold its yen for dollars and
invested this money in U.S. treasuries. As of August 2023, Japan owns a staggering $1.1 trillion of
outstanding U.S. debt, a remarkable 14.7% of the total amount. The second country that holds the most
U.S. debt, another economy whose reliance on exports also causes the Central Bank and government
to constantly intervene in the foreign exchange market with the goal of keeping their exchange rate
stable.
More recently, however, Japan has been struggling with a weakening Yen, hitting a 23-year low in
September of 2022, and one of the main reasons for this is Japan’s decades-long policy of monetary
stimulus and ultra-low interest rates. The yen, due to its historic stability, has long been seen as a safehaven for investors that they traditionally bought when times were rocky. However, this status seems
to be losing its footing, mainly due to the difference in interest rates between Japan and other major
economies. After the financial hardships brought on by the COVID-19 pandemic in 2020, developed
economies were forced to slash interest rates in efforts to boost spending and quickly get their
economies back on track. This in fact is one of the major reasons why many of these same economies
(including the United States and the Eurozone) experienced multiple bouts of inflation in 2022. It’s also
a major determinant of the Yen’s depreciation ever since, particularly because Japan chose not to
follow suit with the rate increases, keeping their main rate near 0.
Difference in Prevailing Interest Rates
Source: International Monetary Fund and World Bank
21
Higher interest rates tend to make currencies more attractive to investors, as this surge in interest rates
in a particular country often translates into higher returns or yields on the bonds outstanding. As such,
investors looking for fixed-income opportunities will flee to countries where interest rates are high, as
bonds in these countries offer greater yields or returns than do bonds in countries where the prevailing
interest rates are low. And given that purchasing a country’s local currency is necessary to acquire their
bonds, massive demand for a country’s bonds can have upward pressure on the currency, and thus
downward pressure on the currency that is being sold in exchange.
This yield spread between U.S. and Japanese government bonds didn’t represent much of an issue for
Japan when it came to currency stability prior to the coronavirus pandemic. In fact, in the midst of the
pandemic years of 2020 and 2021, interest rates between the two countries were very similar, as they
both stood near zero. However, once the economic recovery started to take hold in the U.S., the federal
reserve was forced to quickly raise interest rates in an effort to contain a surprisingly sticky inflation
after what had been a miscalculation on their part (assuming that the inflationary bought that began to
take traction in 2021 would be transitory).
Japan on the other hand, not as concerned with inflation as many other developed economies were at
the time, maintained its notoriously low interest rate of -.1%. During this time, Fed officials have
continued raising interest rates at a historic pace still with the goal of taming the levels of inflation in the
U.S. which has made the gap in interest rates between Japan and the U.S. ever wider.
Now, in mid 2023, the Bank of Japan is becoming increasingly worried about what this has entailed for
the country’s currency.
With the depreciating value of the Yen at the lead, there are many arguments coming together that
might sway the BoJ to adjust its decade-long ultra-loose monetary policy. Coupled with worries about
the nation’s currency also stand rising inflation figures that, while historically low for the country (3.3%
in July), haven’t been seen in the country in decades, and increasing wage pressure that seem to hint
this inflationary period the country is starting to grapple with is not entirely transitory.
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Overview of The Japanese Stock Market
By Ignacio Paz and Devya
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Informational Overview
Japan has four stock exchanges: the Tokyo Stock Exchange (TSE), the Nagoya Stock Exchange
(NSE), the Sapporo Securities Exchange (SSE) and the Fukuoka Stock Exchange (FSE). TSE is the
largest in Japan and the fourth largest globally, with over 3,500 listed companies in 2016. Renowned
multinational companies like Mitsubishi, Toshiba, and Sony actively trade in Japan's stock market.
The Nikkei 225, established in 1950, has become the leading index for Japanese stocks, widely quoted
worldwide. It monitors 225 representative TSE stocks across various sectors, including Asahi,
Mitsubishi, and Nikon.
TOPIX is another essential stock index, tracking the performance of domestic companies in TSE's First
Section. Regular trading hours in the Japanese stock market are from Monday to Friday, 9 am to 3 pm
(12 am to 6 am GMT), with a lunch break between 11:30 am and 12:30 pm.
During the peak of the Japanese asset price bubble in December 1989, the Nikkei 225 index reached
a record high of 38,916.2. However, over the next two decades, the TSE's combined market
capitalisation significantly decreased due to a recessionary condition and a decline in the value of the
Nikkei.
As of August 2023, the board members of the Tokyo Stock Exchange are
• Director (Chairperson of the Board) Kinoshita Yasushi
• Director & Representative Executive Officer, Group CEO Yamaji Hiromi
• Director & Representative Executive Officer, Group COO Iwanaga Moriyuki
• Directors Yokoyama Ryusuke and Miyahara Koichiro
The five largest stocks by market capitalization listed on the Tokyo Stock Exchange as of the end of
July 2021 were (in trillions of Japanese yen):
1.
Toyota Motor Corporation (¥33.904T).
2.
Sony Group Corporation (¥16.415T).
3.
Keyence Corporation (¥15.046T).
4.
Nippon Telegraph and Telephone Corporation (¥14.486T).
5.
Mitsubishi UFJ Financial Group Inc. (¥13.461T).
Source: CNBC
Previously, the Tokyo Stock Exchange (TSE) operated with four market divisions: 1st Section, 2nd
Section, Mothers, and JASDAQ (Standard and Growth). This structure was a result of TSE and Osaka
Securities Exchange integrating their cash equity markets in 2013. To avoid disruptions for listed
companies and investors, TSE maintained the existing market divisions from both exchanges.
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Structural Arrangements
However, this arrangement had two main issues:
1. The concept of each market division was unclear, making it inconvenient for many investors.
2. Overlapping uses between the 2nd Section, Mothers, and JASDAQ markets, as well as
ambiguity around the 1st Section, didn't provide sufficient incentives for listed companies to
increase their corporate value sustainably. Delisting criteria were less strict than initial listing
criteria, and criteria for transfers to the 1st Section were lighter than direct initial listing criteria,
failing to encourage transferee companies to proactively increase corporate value after listing.
As a result, TSE conducted research to restructure the market and introduced three new market
segments on April 4, 2022:
(I)
Prime Market: Designed for companies with appropriate market capitalisation, providing
investment opportunities for institutional investors. These companies emphasise high-quality
corporate governance, commit to sustainable growth, and engage in constructive dialogues
with investors.
(II)
Standard Market: Intended for companies with suitable market capitalisation, offering
investment opportunities in the open market. These companies maintain a basic level of
corporate governance and strive for sustainable growth and improved medium- to long-term
corporate value.
(III)
Growth Market: Tailored for companies with a certain market value that disclose business
plans to achieve high growth potential and update their progress accordingly. However, these
companies also pose a relatively high investment risk due to their business track record.
In April, Japan witnessed significant foreign investor net equity inflows, amounting to $15 billion, making
it the top destination for foreign investment in the region. India followed with a more modest $1.92 billion
in net equity inflows, according to data from Morgan Stanley. However, the situation was different for
Taiwan, which experienced the largest outflows at $1.7 billion, along with China, as geopolitical risks
added to market uncertainties.
Jon Withaar, head of Asia special situations at Pictet Asset Management, finds Japan a more attractive
prospect for chasing value compared to China. Consequently, his firm has recently increased its
exposure to the Japanese market. Moreover, UBS global strategists are recommending investors to be
long on Japan instead of U.S. equities for the rest of the year, signalling their confidence in the
Japanese market's potential.
One attractive aspect of the Japanese market is its relatively cheap valuation. The market is currently
trading at a price-to-earnings ratio of 17.6, which is notably lower than the Nasdaq's 27.6 and the S&P
500 index's 22, as reported by Refinitiv data. This lower valuation may present appealing opportunities
for investors seeking value in the market.
However, some large investors remain cautious and have not fully participated in the recent market
rally. Their concerns stem from historical instances of the Nikkei underperforming, leading to scepticism
about the market's sustainability. Additionally, uncertainty surrounds the timing of the Bank of Japan's
unwinding of its massive monetary stimulus, which could have implications for the stock market.
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Technical indicators are also suggesting that the Japanese market might be overheated. Both the
Nikkei and the broader Topix index are currently in overbought territory, making them susceptible to
profit-taking actions by investors.
T&D Asset Management, among others, is forecasting a potential decline in the Nikkei by the end of
the year. They predict the index may drop to 27,500, representing a nearly 14% decrease from its
current levels. As with any prediction, this outlook is subject to various market dynamics and potential
shifts in investor sentiment.
In summary, Japan's stock market has attracted substantial foreign investor interest, while Taiwan
experienced significant outflows. Investors and experts have differing opinions on the market's
prospects, with some seeing it as an appealing value proposition and others expressing caution due to
historical trends and technical indicators. As always, market conditions can change rapidly, and
investors should carefully consider their strategies based on comprehensive analysis and risk
tolerance.
Drivers of Recent Performance of Japan’s Stock Market
Japan's equity market has recently experienced a confluence of positive developments, propelling
Japanese equities to levels not seen in over three decades. These favourable factors include Warren
Buffett's visit to Tokyo in April, which was seen as an endorsement of Japanese equities. Additionally,
Japan's strong focus on improving governance standards, driven by initiatives from the Tokyo Stock
Exchange (TSE), has played a crucial role. Furthermore, a weaker Japanese yen and a surge in share
buyback announcements have provided tailwinds during the earnings season, bolstering investor
confidence.
Source: The International
In January 2023, the TSE launched a campaign to encourage Japanese companies to enhance their
appeal to investors. As part of this initiative, companies trading consistently below book value are
required to submit an improvement plan or provide an explanation. Notably, almost half of the listed
companies on the Prime Market, which has the highest listing standards, exhibit a return on equity
below 8% and/or a price-to-book ratio below 1.0. This suggests potential issues with profitability, cost
of capital, and growth. The TSE's emphasis on "comply or explain" aims to drive companies towards
actions that enhance their medium- to long-term corporate value, including adopting "cost-of-capital
conscious management." Historically, some Japanese management teams have shown limited
awareness of cost-of-capital and its implications for share prices, making a shift towards cost-conscious
management crucial for bolstering capital efficiency and overall credibility.
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Lazard Asset Management's interactions with Japanese business leaders indicate that management
behaviour may be improving, signalling progress towards the TSE's goal of empowering investor
engagement. This trend aligns with the ongoing efforts towards improved corporate governance in
Japan.
For investors, this presents a promising opportunity, as Japanese companies have significant potential
to increase their corporate value through better capital efficiency, portfolio reorganisation, and improved
shareholder returns. Similar scenarios have played out successfully in the United States during the
1990s and in Europe during the 2000s. Investors focusing on fundamental analysis are well-positioned
to understand the situation, drive positive change on a company-by-company basis, and reap financial
benefits. However, the magnitude of this transformation might still be underestimated by many global
investors, and its full impact may not be adequately reflected in longer-term valuations.
In conclusion, Japan's equity market has been positively influenced by various factors, including Warren
Buffett's visit, efforts to enhance corporate governance, and supportive economic conditions. The TSE's
push for improved investor appeal and cost-conscious management further adds to the potential for
positive change in Japanese companies. Investors who recognise the opportunity and take decisive
action may benefit significantly from the untapped potential of Japanese equities
Investors Are Putting Big Money Into Japan Again
First, let’s observe what are we talking about (Nikkei 225 relative the SP500):
Source: New York Times
In 2014, the Japanese Prime Minister, Shinzo Abe, confidently declared his intention to revitalize the
traditional ways Japanese companies operated, which had stagnated for years. Economic hardships
following the 1980s bubble had caused Japanese executives to adhere strictly to the status quo,
resulting in limited employee raises and shareholder returns, leading to sluggish economic growth.
However, signs now indicate a significant shift in how the country's corporations are managed,
contributing to the resurgence of the economy. Recent developments include Canon shareholders
demanding a diverse board of directors, Citizen Watch committing to buying back up to a quarter of its
shares, and Uniqlo's owner promising substantial raises for its workers. Moreover, the Tokyo Stock
Exchange is urging companies to be mindful of their share prices.
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Japan's stock market, the Nikkei 225 index, has surged nearly 30% this year, outperforming the S&P
500 in the United States. The country's economy, ranked third-largest in the world, is also benefitting
from a solid economy this year, a weak currency, ultralow interest rates (in contrast to other major
economies), and an endorsement from Warren E. Buffett.
Although some warn of past disappointments due to overly optimistic expectations about changes in
Japanese boardrooms, company profits are improving, and Japan's economy is thriving postpandemic. Inflation has returned, consumer spending is rising, and foreign tourists are returning,
boosting the domestic demand.
Despite the positive outlook, sustaining and broadening the increase in incomes for various segments
of the economy remains a challenge. The government is focusing on raising wages and implementing
labor market reforms to address these issues.
The Tokyo Stock Exchange is also pushing for a change in corporate thinking by planning to force
undervalued companies to increase their stock prices. As a result, companies like Toyota and Honda
may need to make adjustments.
Source: Hartford Courant
The hedge fund manager, Seth Fischer, who has been advocating for change at Japanese companies,
has noticed significant improvements in senior executives' behavior. Canon, for example, faced
reprimands from shareholders regarding gender diversity among directors, and Japanese corporations
have announced a record $70 billion in buybacks in the last year. Dividends are expected to surpass
$100 billion this year, injecting money into the real economy.
Plus, as seen previously, the increase in Japan’s GDP for the first three months of the year was revised
sharply up last week, to an annual rate of 2.7% from an initial reading of 1.6%. The overall picture
remains mixed because the bump that came from more spending by companies was geared more to
restocking the shelves and warehouses, not demand from customers. Private consumption, a gauge
of how much people are spending, weakened slightly.
Additionally, Warren E. Buffett's endorsement of Japanese conglomerates has drawn foreign investors
into Japanese stocks, diverting attention from China amid escalating tensions between Beijing and
Washington. Overall, investors have become aware of the transformative opportunities in Japan, and
as companies take actions to enhance their value, they are expected to boost Japan's economy by
increasing incomes.
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Metrics
These are some metrics that we would like to highlight:
Japan YTD % Return Relative to Other Geographies
Source: Schroders
The increasing enthusiasm for Japanese shares can be attributed to two main factors. Firstly, there is
a cyclical aspect, as the Japanese economy reopened relatively late after the Covid-19 pandemic. This
delayed reopening instills confidence in corporate earnings growth for the current year. Additionally,
the Japanese stock market as a whole offers attractive valuations.
Secondly, a more significant and long-term driver is the Tokyo Stock Exchange's (TSE) call earlier in
the year for companies to prioritize sustainable growth and enhance corporate value. This call was
particularly aimed at companies with a price-to-book ratio below one, signaling a push towards
improving the overall financial health and prospects of such firms.
TOPIX Price-to-Book ratio Distribution
Source: Bloomberg
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Basically, the low P/B ratios under one indicate that investors have still a very sceptical view of these
companies’ future profitability and growth potential and thus, TSE specifically pointed out that a
company should seek higher ROE while measuring and managing cost of capital.
These are exactly the topics global investors wish to talk about with company management, and we
think this is finally gaining official acknowledgement by Japanese companies.
Indeed, there are a lot of companies listed in Japan with P/B ratios below one. That means there are
lots of companies with the potential to be revalued more highly - if they can convince investors that they
should be.
TSE has urged companies to make plans to be revalued by focusing on cost of capital and share price.
Companies are expected to announce their plans within a year and renew them annually.
Net Cash (with Potential to Inverst or Return to Shareholders)
Source: Schorders, Bloomberg
There are positive indications that numerous Japanese companies are responding to the Tokyo Stock
Exchange's (TSE) call and taking steps to boost returns to their shareholders. These encouraging
developments were observed during Japan's full-year earnings season from May to June, which
brought about a pleasant surprise.
In the fiscal year ending in March 2023, the amount of share buyback plans announced by companies
reached a historical high, surpassing the levels seen in the previous two financial years.
This surge in buyback announcements reflects a growing trend of companies allocating more funds to
repurchasing their own shares, potentially signaling increased confidence in their financial positions
and a commitment to enhancing shareholder value.
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Share Buybacks (More Popular than ever)
We are also seeing companies announce new medium-term business plans which include more
aggressive dividend pay-out policies. Notably, this has been the case more from small and mid cap
companies, including some in old-fashioned industries such as construction and chemicals. We even
saw a case where a company decided to pay out 100% of its profits by making use of its idle cash on
the balance sheet.
Post-Covid Boost
TSE’s call for Japanese companies to increase their P/B ratios is far from the only factor helping to
support shares this year. The country’s delayed reopening from the pandemic is another.
Japan was under some form of pandemic restrictions for much longer than the US or Europe. The
country only reopened its borders to foreign tourists in October 2022. Domestic travel is also recovering.
We think this can help benefit smaller, domestically-focused companies operating in sectors such as
travel, leisure, and hospitality.
Another important point is that China’s lifting of pandemic restrictions was even later than Japan’s.
Trade with China is important for Japanese companies, and Chinese tourists were a sizeable
proportion of total visitors to Japan (making up a third of the total in 2019). China’s belated post-Covid
reopening is another positive influence for Japanese shares this year.
Welcome return of inflation
Of course, the benefit from lifting pandemic restrictions is a one-off. There are other longer-term factors
supporting the Japan story too. Among these is the return of inflation. After three decades of low
inflation, and even deflation, the current return of mild inflation is very welcome in Japan. Deflation
leads companies and consumers to delay investment and put off purchases; there’s little point buying
something now if it will be cheaper tomorrow. By contrast, moderate inflation gives companies the
confidence to invest for the future, and also spurs consumers to spend. Rather than facing a downward
deflationary spiral, Japan may now be entering a sustained period of higher corporate investment, wage
growth, and increased consumer spending.
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32
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Capital IQ Link:
https://www.capitaliq.spglobal.com/web/client?auth=inherit#country/economicDemographic?ke
ycountry=JP
…Thanks for Reading
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