Gambarimasu! - 'To do your best', or 'to be tenacious in tough times!'

Prior to my career in Davy, I had the dubious pleasure of covering the Japanese equity market for over a decade. Why dubious? Well, as much as I love all things Japan (and I do), the challenges of managing equities in an economy that refuses to grow, in a market with persistent deflation, and in a rapidly ageing society were numerous. Throw in the odd earthquake and existential threat from North Korea and evidently the job wasn't dull! Furthermore, given these long-term issues, it's fair to say that many investment houses were not always keen to invest in Japan generally speaking. 

However, markets can be fickle, and so every few years with periodic regularity there was a rush by big global investors to embrace Japanese equities. The enthusiasm could usually be measured by attendance at the spring investment conferences in Tokyo. Busy rooms full of 'gaijin' (non-natives) eager to make a foray into Japanese equities and encountering puffer fish and other delicacies for the first time was usually a sign for me to exit stage left. The catalysts for this rush into all things Japan were varied. It could be green shoots surrounding political stability; or rumours that Japanese companies would finally embrace higher returns; but the great white hope was always the 'big one' - the end of deflaion in Japan. No longer would Japanese people be able to keep their hard-earned cash under their futons, and no longer would the annual wage negotiations ('shunto') result in stagnant salaries. Instead, investment products would be king, consumers would buy today rather than tomorrow, and life would be great... at least that's until everyone got too old. 

Unfortunately for investors, the result was inevitably disappointment. Political instability and currency fluctuations played a part, but ultimately deflation, once it entered the Japanese mindset, was a hard feature to get rid of. After all, why would one buy anything today when it was going to be cheaper tomorrow?! This was also true of stocks and indices. If one had invested in Japan back in 2000, your reutrns today, 23 years later, would be a measly 17% over a 23 year period. 

At the root of some of the low investment returns was also a poor management mindset in corporate Japan. Large cross-shareholdings in many institutions made this possible to some extent. If a large portion of your shares are owned by a subsidiary/related company, there is little incentive to improve returns. After all, those shareholders are highly unlikely to vote against management! Additionally, even if any shareholders wanted to be 'activist', it was logistically nigh on impossible. Japanese companies' year-end is March, making June a natural time to hold Annual General Meetings. However, harking back to the mid-1990s, 96% of companies held their AGMs on the same day in June! Even the most dedicated of investors would struggle with this short timeframe for active voting.

Of course, as an island nation, currency has also always played a role in the attractiveness of industry in Japan. To mitigate this, many Japanese companies opened manufacturing sites outside of Japan in regions such as the US and elsewhere in Asia. This could kill two birds with one stone in some cases, as some penal US quotas could be avoided - particularly in the car manufacturing sector. The end result was a hollowing out of Japanese industry. Despite this, the market performance has, to a large extent, remained very linked to the yen/dollar rate, with a weak yen typically good for market performance (as we have seen this year).

So, with the benefit of long experience, has anything changed this time? Well, to begin with, I have to say from a political standpoint, stability has most definitely improved. Following a revolving door policy of prime ministers for many years (an impressive three prime ministers lasted less than ninety days in one infamous five-year period), having prime ministers in power for more than a wet week has allowed economic policies to have an impact. Arguably the defining era came from Shinzo Abe, Prime Minister (for the second time!) from 2012 - 2020. He had particularly strong views on government spending, reflation, and growth, and set out several economic policies to achieve these goals - so-called 'Abenomics'. One area targeted was corporate governance reform, with the introduction of the Japan stewardship code and corporate governance code having a long-term impact on cross-shareholdings and board structure. 

One corollary of this has been the impact on Annual General Meetings. Whilst still pretty concentrated, nowadays just under 80% of companies hold meetings over seven days at month-end. Together with a reduction in cross-shareholdings, this has allowed some activism for inefficient corporates. The most recent example would have been unheard of in previous years, with many shareholders recently voting against the re-appointment of a member of the founding Toyoda (Toyota) family as chairman. 

Further reform is coming. Most recently a Tokyo Stock Exchange (TSE) Index ruling, announced in late March this year, is likely to bring further reform. The ruling suggests that listed companies should disclose their cost of capital; whether or not the company has achieved profitability that exceeds that cost of capital (and if not, why?); and finally, if the company's Price/Book ratio is lower than one, reasons why that is. Whilst no specific timeframe was announced, in a market where 50% of the market still trades on Price/Book of less than 1, some re-rating of the market would appear likely. Despite a considerable re-rating this year, the Topix remains attractive on both a relative and absolute basis on other valuation metrics such as the Price/Earnings ratio.

Let's not forget investment in industry. With US-China relations struggling, and economic securty under pressure, coupled with a weak yen, Japan seems once again a more attractive place for investment - in particular for the tech sector. And whilst the Bank of Japan has not yet raised rates, with the most recent inflation number in Japan hitting a lofty 3.5% consumer prices are finally rising at giddy levels. 

To summarise: Japan is relatively cheap, deflation would appear to be finally over, and reform is here. What's not to love? However, a tale of caution as this is not my first rodeo. Japan's society is rapidly ageing, and in an economy that remains stubbornly anti-immigration, this will be a problem in the not-too-distant future. In addition, potential earthquakes and North Korea remain a constant rumbling threat. In the meantime, the investment conferences in Tokyo are no doubt booming once again - pufferfish anyone?