Lazard Insights
Abenomics and the Japanese Revival
Timothy Griffen, Managing Director, Portfolio Manager/Analyst
Summary
• Japanese equity valuations are at all-time lows
despite the Topix Index almost doubling in two
years.
• Although western commentators have dismissed
Abenomics as a failure, Japanese companies
have become more profitable and are acting in
the interest of shareholders with rising dividends,
buybacks, and return on equity (ROE).
• As the Japanese economy emerges from its
low-growth, deflationary slump and corporations
normalize, we believe it is critical that investors
have a more thorough and in-depth understanding
of the complexities of what remains one of the
world’s largest and deepest equity markets.
Lazard Insights is an ongoing series designed to share valueadded insights from Lazard’s thought leaders around the
world and is not specific to any Lazard product or service.
This paper is published in conjunction with a presentation
featuring the author. The original recording can be accessed
via www.LazardNet.com.
Japan—Cheap and Changing
Since the Japanese market peak in 1989, equity valuations have fallen
steadily and currently trend around lows not seen since the early
1980s. In other developed markets where there is modest inflation,
similar to Japan, price-to-book ratios are generally around 2 times as
compared to Japan’s Topix Index price-to-book ratio which is only
slightly over 1 (Exhibit 1, top chart). This significant difference suggests that the Japanese market continues to be somewhat fixated with
its deflationary past and has yet to embrace the possibility of more
secular change. Japanese price-to-earnings ratios tell a similar story.
Despite the Japanese market almost doubling since the election of
Prime Minister Shinzo Abe two years ago, price-to-earnings ratios
remain at their all-time lows as corporate profits have actually been
rising on pace with the market (Exhibit 1, bottom chart). In effect,
valuations in Japan remain as compelling two years into the launch of
Abenomics as they did at the outset.
Corporations in Japan have historically had weak balance sheets and
an ongoing need to repay bank borrowings. Recently, however, there
has been a substantial improvement in the equity ratio for Japanese
companies and are now, on average, on par with their global peers.
The long drawdown of resources to pay debt has finally come to an
end. The risk that companies will be forced to issue equity to stabilize
their business is very low. In fact, extremely cautious corporate CFOs
in Japan have led to a massive accumulation of cash on balance
sheets. Over 50% of all Japanese companies have net cash on their
balance sheets. In other words, these companies are effectively debt
free.1 While this may seem illogical, it was a sensible strategy, since
cash’s value rises in real terms with persistent deflation. Moreover, the
2
psychological effects of having dealt with a deflationary environment
for twenty years are likely to linger for some time among corporate
CFOs even after Japan’s deflation has come to an end. This is why the
Abe administration’s initiatives to encourage corporations to shift their
focus away from balance-sheet strength to profit improvements are so
critical. Convincing corporations that deflation has come to an end
and effecting a change in behavior is a major force behind revitalizing
the private sector.
Exhibit 1
Japanese Equity Valuations Are Attractive
Japanese Equities Have a Very Low Price-to-Book Value Despite Rising Inflation
Topix Index Price-to-Book Ratio
4.5
3.0
The government is already having some success, as evidenced by the
consistent rise in the average stock buybacks by Japanese companies.
In fact, aggregate stock buybacks are on pace to almost double the previous fiscal-year peak at close to 7 trillion yen ($60 billion in US dollar
terms).2 This change in attitude among corporate executives coincides
with the 2012 election which brought Abe to power. Leading up to
the 2012 election, Japan was facing a crossroads to either continue
down the path of low growth, persistent deflation, geared for its aging
population and gradually fading from the world stage or reclaim its
position as one of the world’s leading economic powers and a major
contributor to world growth and prosperity. Abe clearly ran on a
platform embracing the latter, a policy shift which now bears his
name—Abenomics.
1.5
0.0
1973
1981
1989
1998
2006
2014
Price-to-Earnings Ratio Is at All-Time Lows
Topix Index Price-to-Earnings Ratio
36
30
Despite Abe’s desire to push Japan in a new direction, convincing
investors that real change is occurring and that the economy is normalizing has been a challenge. For instance, the price-to-book ratio of
companies broken down by Tokyo Stock Exchange sectors versus their
10-year median, indicates that stable defensive sectors like services,
foods, pharmaceuticals, and land transportation are trading at recordhigh levels relative to their long-term median, while pro-cyclical
reflation sectors, like banks, real estate, and iron & steel are at record
lows (Exhibit 2). Clearly not all investors are convinced by Abe’s
attempts at reform. According to the market, the situation in Japan
has not changed and is doomed to continue on its twenty-year past of
persistent deflation and little economic dynamism.
24
18
12
Apr 10
Nov 11
Jun 13
Jan 15
As of 10 February 2015
The index listed above is unmanaged and has no fees. It is not possible to invest
directly in an index.
Source: Bloomberg
Exhibit 2
Divergence in Valuation: Cyclical and Defensive Sectors
Price-to-Book Ratio by Sector for the Tokyo Stock Exchange
3.0
10-Year Values:
2.0
75th Percentile
Median
25th Percentile
Average for TSE
1.0
As of 30 January 2015
Source: Toyokeizai, Nikkei, and IFIS, compiled by Mizuho Securities Quantitative Strategy
Banks
Mining
Pulp & Paper
Oil & Coal Prod.
Wholesale Trd.
Maritime Trans.
Insurance
Iron & Steel
Nonferrous Metals
Sec. & Cmdty. Futr.
Wareh. & Harb. Trans.
Metal Products
Other Finan. Bus.
Glass & Ceramic
Elec. Power & Gas
Other Products
Textiles & Apparel
Construction
Fish/Agr./Frst.
Chemicals
Transport Equip.
Machinery
Air Transport
Info. & Comm.
Rubber Products
Electric Appl.
Land Transprt.
Real Estate
Retail Trade
Pharmaceuticals
Foods
Precision Instr.
Services
All TSE1
Ex Financials
0.0
3
One of the more remarkable success stories of Abenomics has been the
rapid rise in women participation in the workforce, which is now at an
all-time high. Despite this, the labor market is becoming increasingly
tight with unemployment and job offer levels not seen in several years
(Exhibit 5). This is feeding through to higher household income levels
and improved consumption.
One way to determine if deflation in Japan has ended is to track bank
lending. In a persistent deflationary environment, the logical thing to do is
to pay down debt which rises in real terms. Hence, in looking at the trends
since Abe was elected, bank lending has grown consistently at a 2% pace
over the last two years (Exhibit 6). This is an initial indication that individuals and corporations are convinced that deflation is a thing of the past.
100
60
20
2012
2013
2014
2015
2014
2015
Dividends Have Increased 60%
Topix Dividends per Share
25
21
17
2012
2013
Topix Return on Equity Has Doubled
Topix ROE (%)
10
5
Feb 15
Dec 14
Jun 14
Sep 14
Mar 14
Dec 13
Jun 13
Sep 13
Mar 13
Dec 12
Jun 12
Sep 12
Dec 11
Mar 12
Jun 11
Sep 11
0
Mar 11
A recent development has been the rapid improvement of Japan’s net debt
to GDP ratio. Rising tax revenues have lowered borrowing costs. Further,
better returns on invested pension assets have allowed the government to
reduce pension funding with bond issuance. Lastly, the improvement in
nominal GDP has raised the denominator in the calculation (reducing
overall debt to GDP). In total, Japan has seen a remarkable swing from
debt to GDP since Abe was elected. The Ministry of Finance in Japan has
been curiously quiet about this, as they would prefer to keep the politicians’ feet to the fire and have them remain committed to fiscal reform.
Topix Earnings per Share
Dec 10
The really good news is that some of these newfound profits are finding
their way into consumer pocketbooks. Japanese companies pay salaries
on an 18-month cycle, 12-month base pay and a 6-month variable
bonus paid twice a year. The variable bonus component of pay was up
sufficiently (Exhibit 4) to raise overall compensation by 2.7% in 2014. In
2015, wages are expected to grow in both nominal and real terms. This is
important because personal private consumption represents 63% of GDP
and therefore a bump to GDP is expected due to positive wage news.
Corporations Earnings per Share Have Doubled
Jun 10
Companies have responded to this improved profitability by raising dividends. Historically, Japanese corporations opted to pay a stable dividend
rather than one that rises and falls with profitability. However, there has
been a change in management thinking regarding their dividend policy,
which we believe is almost certainly influenced by the Abe administration’s corporate reform initiatives. Similarly, average corporate ROE has
doubled in the past two years and is set to eclipse 10% for the first time
since the 1970s. The recovery in ROE has two components. The first is
due to the managements’ focus on their companies’ core competence
and eliminating businesses which do not cover their cost of capital. The
other is the revival of both revenue volume and pricing power, something Japanese firms have not experienced in over twenty years.
Exhibit 3
Japanese Companies Are More Profitable Since the Onset
of Abenomics
Sep 10
An analysis of the last two years paints a very different picture of
where Japan is today than where one would surmise by reading the
opinion of western commentators or looking at the internal sectors
in the market. Exhibit 3 highlights some key indicators in terms of
profitability and dividend policy. Corporate earnings have risen precipitously over the last two years and within this trend it is noticeable
that domestic-demand focused companies have seen profits rise faster
than exporting and globally oriented firms. Clearly, it is more than
just a weak currency driving the profit revival in Japan.
Mar 10
Has Abenomics Failed?
As of 10 February 2015
Data are based on Tokyo Exchange Tokyo Price Index Topix. Earnings data are annual
frequency and in yen. Dividends and ROE data are quarterly. The index listed above is
unmanaged and has no fees. It is not possible to invest directly in an index. Past performance is not a reliable indicator of future results.
Source: Bloomberg
Exhibit 4
Bonuses Appear to Be Back to Pre-Crisis Levels
Average Large-Company Summer and Winter Bonuses
(%)
(JPY, thousands)
925
20
YOY Change [LHS]
Summer Bonus [RHS]
Winter Bonus [RHS]
10
875
0
825
-10
775
-20
725
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
As of May 2014
Source: Keidanren
4
Third Arrow Reforms and Conclusion
Exhibit 5
Abenomics Has Led to Greater Female Labor Force
Participation and a Tighter Labor Market
Close to seventy separate pieces of legislation for reforming Japan’s
economy have been passed since Abe took power, a remarkable
legislative performance. We believe one of the primary reasons overseas investors have been negative on the third arrow of reform and
Abenomics is because of the lack of a single large and tangible outcome. This was never the intention of the third arrow. The third arrow
was always about a series of reforms across a range of sectors of the
economy that together would revitalize the nation. On this metric, the
pace of the reform initiatives is high. The next phase is to monitor the
execution of these reforms in a practical sense.
Female Labor Force (persons, millions)
29.0
28.5
28.0
27.5
27.0
2009
2010
2011
2012
2013
2014
May 14
Dec 14
Job Openings-to-Applications (ratio)
1.2
1.0
0.8
0.6
Jan 12
Aug 12
Mar 13
Oct 13
Unemployment Rate (%)
6
5
4
3
2
1993
1996
1999
2002
2005
2008
2011
2014
As of 31 December 2014
Source: Bloomberg, Haver Analytics
Exhibit 6
Japan Bank Loans Have Grown for Two Consecutive Years
Japanese market valuations are cheap and do not reflect that the
country is potentially emerging from its deflationary slump. The
implications are profound if a country the size of Japan were to suddenly start experiencing a reflationary economic revival. For the last
twenty years the Japanese market has been out of sync with the rest
of the world, as evidenced by its low correlation to other developed
markets: 0.69 for the period January 1990 to September 2014. By
contrast, the correlation of the United States and the United Kingdom
with other developed markets is 0.90 and 0.87, respectively.3
Interestingly, Japan’s low correlation includes a large component of
global companies which are inevitably linked to the global economic
cycles and pure plays on domestic Japanese economic revival offer
massive diversification benefits to investors.
In addition to the diversification benefits, the twenty-year slump in
asset prices meant that the financial services industry has seen a collapse
in employment (Exhibit 7). For years, it has been easy to lump all of
Japan into one macro tactical trading-based decision, therefore, on-theground research was considered a luxury. Today, with the economy
normalizing corporations acting in the interest of shareholders with
rising dividends, buybacks, and ROE, and more reform coming, it is
critical that investors have a more thorough and in-depth understanding of the complexities of what remains one of the world’s largest and
deepest equity markets. Like the emerging markets of a decade ago, we
believe investors will increasingly find that a dedicated allocation to
Japan is the most efficient way to capture this opportunity.
Exhibit 7
Coverage of Japanese Equities Is Scarce
YOY Growth (%)
Total Number of Employees in Japanese Securities Firms (thousands)
3
170
2
140
1
110
0
2011
2012
2013
2014
80
1982
1990
1998
As of 31 January 2015
As of 30 June 2014
Source: Bloomberg
Source: Lazard, Japan Securities Dealers Association
2006
2014
5
Notes
1 As of 29 May 2014. Source: J.P. Morgan, Bloomberg.
2 As of 29 May 2014. Source: J.P. Morgan, Bloomberg.
3 Data are based on the MSCI World Index, as of 30 September 2014. Source: MSCI.
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Published on 27 February 2015.
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