Waiting for Japan to bounce back has taken my whole working life. I lived there at the height of its legendary property and stock market bubble in the late 1980s. One urban myth at the time said the grounds of the Imperial Palace were worth as much as California. It was impossibly exotic and quite mad. I loved it.
In the intervening three and a half decades, Japan has been a by-word for deflation, dreadful demographics and dismal growth. Its stock market was bigger than America’s back then. Today the US market is worth ten times as much. When the bubble burst in 1990, the Nikkei 225 index fell from a peak of 38,000 and didn’t stop until it had lost three quarters of its value in a little over a decade. After the financial crisis, it then bottomed out at 7,000.
The last decade or so has been kinder to investors in Japan. Starting from such a low base it would have been strange if it had not been. But even after years of massive fiscal and monetary stimulus, and a decade after the far-reaching reforms of late prime minister Shinzo Abe, Japanese stocks remain under water. It took until 2021 before the Nikkei clawed its way back to 30,000, still a quarter below the peak. No wonder one of my more cynical colleagues used to say: it’s never too late to short Japan.
Except that now it just might be. For the first time since my twenties (and that is a while ago), Japan is hot. Year to date, the Tokyo market is up 19pc. It’s risen 7pc since the beginning of the month. Shorting the Japanese bond market was famously known as the ‘widow-maker’ trade, so many careers had it ruined. But today the riskiest bet looks to be scepticism about Japan’s resurgent equities.
So, what’s the case for Japan? What’s changed to make grizzled Nikkei watchers, so accustomed to disappointment, describe this as a once in a generation opportunity? What is it that has brought the king of value investors, Warren Buffett, back to Tokyo?
The first reason is the simplest of all. It is cheap. And not just when measured against companies’ earnings, although it is on this basis too. For a slice of the US market, you will need to pay nearly 19 times expected earnings today. In Japan, the equivalent multiple is just 14, even after the recent rally. But where Japan’s companies really start to look interesting is compared to the value of their assets. It has been decades since a US investor could buy a big American company at less than its book value. In Japan, businesses routinely trade at less than their intrinsic worth. Many are awash with cash, burning a hole in their shareholders’ pockets.
In fact, this discount to net assets is so common that the Tokyo Stock Exchange has explicitly targeted the measure in its bid to make Japanese companies more attractive to shareholders globally. After years of treating shareholders pretty much as second class citizens, Japanese companies are being encouraged by government, the central bank and the stock exchange to put their owners first. And they are responding. Share buybacks and dividend payments have soared. There is a palpable sense of change. Improving corporate governance is the second reason to rethink Japan as an investment destination.
The third is the return of a Goldilocks level of inflation. For years Japan suffered from the opposite problem. Deflation is a killer for economies and asset markets alike. When things are likely to be cheaper next year than this, there is no incentive to replace or invest. And many things were until very recently no more expensive than when I lived in Japan 35 years ago. Today, inflation is back above 3pc. It’s sitting in the sweet spot between the falling prices of old and the too rapidly rising prices the rest of us are grappling with.
A fourth reason some investors like the look of Japan right now is that it is not China. It is on its doorstep, benefiting from its tourists and the ability to sell its robots and cars and machinery into its big neighbour. But it comes without the political uncertainty and iffy relationship with the US. The war on Ukraine, and ties between Russia and China, clearly triggered a rethink of Japan’s place in a rapidly changing geo-political landscape. It is no coincidence that despite the rising cost of energy and Japan’s prolonged Covid winter, it was one of the better performing markets in the world last year, even before this year’s take-off.
The appeal of Japan is becoming clearer to foreign investors, but where things could get really interesting is if domestic Japanese investors wake up to the opportunity under their noses. Data from the Bank of Japan and Goldman Sachs suggest that Japanese households on average hold just 10pc of their assets in shares, compared with 20pc in Europe and 40pc in America. By contrast 55pc of their wealth is stashed away in very low-yielding cash deposits. The equivalent numbers are 14pc in the US and 37pc in Europe.
That is a veritable wall of money waiting on the side-lines. Each percentage point shift from cash to equities is the equivalent of more than AUD$1.8bn pouring into the Japanese stock market. Add in overseas investors and share buybacks and soon you’re talking about a sizeable mismatch between the supply of and demand for Japanese shares. There is still some way to go before the Nikkei regains its 1989 peak. But with this combination of tailwinds, the long wait may soon be over.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
