Our Perspective.
After three decades marked by deflationary woes and a seemingly ever-increasing number of widows, the sun may finally be shining on Japan. Equity markets are making all-time highs for the first time since 1989, amidst talk of an end to deflation and what is generally perceived to be a beneficiary to a stumbling China. Investment conferences are filled with Japanese equity market bulls on what has become a market darling.
So, this month we ask ourselves, has Japan become a consensus trade?
In local currency terms, the TOPIX Index is up 52% in the last two years, whilst the S&P 500 is up mere 22%. Granted, you’ve given back about 35% in currency terms. However, returns have been robust whilst the currency has reached extreme disparity from fundamentals such as unit-labour cost and purchasing price parity.
One might question, however, whether Japan is really exiting out of their decades of deflation. Whilst strong wage growth suggests otherwise, the reality is inflation in Japan is abating relatively quickly, like other parts of the world. Japanese PPI fell back to a meagre 0.2% in January – down from a 44-year high of 10% in December 2022 – whilst the economy seems to have slipped back into a recession. This will mean the chances of an end to the era of ultra-supportive policy will likely take a little longer than optimists might suggest.
But let’s look at the data:
As table 1 shows, since the end of 2012 dividends per share in Japan has grown at an average of 9.9% per annum, whilst dividends in the US have only grown by about 7.5%. Earnings Before Interest and Taxes (EBIT) have grown by almost 8% in Japan, whilst EBIT of the S&P 500 have grown by a mere 5.7%.
The estimated dividend yields on the TOPIX Index is 2.2%, compared to a rather whimpering 1.5% from the S&P. At the same time, we expect dividend growth to remain robust given the strong and generally overcapitalised balance sheets, alongside ongoing governance reform. And the difference is not made up through buybacks, with aggregate buybacks in Japan now equalling the US on a percentage basis.
We also looked into official data on foreign investor flows into Stocks and Equity Funds. Surprisingly, as chart 2 below shows, Japan has actually experienced outflows from foreigners over the last 12 months. This might highlight scepticism…or perhaps proof that Japan is anything but a consensus long!
To conclude, investors should look to continue to increase exposure on weakness. Inefficiencies remain rather significant, and we continue to believe investors should embrace active managers that specifically target these. Whilst the TOPIX Index is up 250% since the end of 2012, the reality is that the equity market has not kept up with profit growth and shareholder value creation, driven by these reforms. Indeed, valuations today are more attractive that they were a decade ago when ‘Abenomics’ was introduced. The late prime minister Abe’s ‘Third Arrow’, which focus on improving governance and increasing shareholder returns, are still in its infancy. Balance sheets remain (too) strong, profitability continues to rise, and a significantly undervalued Yen provides investors with healthy optionality. The sun is only just starting to rise!
To view our graphs and data tables, please download the full article below.
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