Surprising facts about an unloved destination for many investors
What if we told you there is a country with some of the most densely populated cities, but fastest trains on earth, with average delays of only 18 seconds? Hardly imaginable, if you travel by train in the UK. What if we told you that country also has one of the most rapidly improving free-market capitalist economies? And its companies are becoming increasingly shareholder friendly? On top of all of that, its stock market looks cheap? You’d probably say we were dreaming.
But this is no figment of our imagination — it’s Japan. Investors have become accustomed to the old cliché that it’s “just another false dawn in the Land of the Rising Sun”. So it is that Japan remains unloved and the only major market, excluding the Brexit-dogged FTSE 100, not to undergo a substantial increase in valuations (a ‘re-rating’ in market jargon) in the long-lived global bull market that continues to stampede ahead.
Healthy underlying economy
This is despite return on equity, a measure of the value being delivered to shareholders, improving more than in any other major region. Since Prime Minister Shinzo Abe came to office at the end of 2012, the average price relative to earnings (PE) of Japan’s Topix index has increased by just half of the rate enjoyed by European equities. Earnings growth in Japan has been six times that of Europe, with almost three times the dividend growth and twice the gain in prices.
This strong growth in profits has been supported by a healthy underlying economy. Japan also boasts the strongest growth of GDP per capita of any major developed country over the five-plus years that Abe has been in office (figure 6). This is in no small part due to the fact that Japan is also one of the few countries to have embarked on a thoughtful and wide-reaching series of structural reforms.
Figure 6: Measuring wealth
Japan's GDP per capita has outperformed most other major regions over the past 10 years.
Source: Datastream and Rathbones.
By late 2016, many foreign investors had lost patience with these reform efforts, which by their nature take time to filter through to company profits and other measures of shareholder value, and had sold out of Japan by early 2017. The available data on fund flows suggest they are yet to return in any meaningful way.
A weak set of GDP growth numbers in the first three months of 2018 didn’t help encourage investors back. But we see this as an opportunity. We don’t believe it’s the start of something sinister. Japan’s Tankan Survey of business conditions is at the highest level since 1991; the Shoko Chukin survey of small and medium-sized firms is also sending a healthy signal.
On top of that, Japan’s unemployment rate is an astonishingly low 2.5%, and the labour force participation rate has shot up to a 15-year high as wage increases and childcare reforms are enticing more women back into the workforce. This should lead consumer confidence higher. At the same time, operating margins (a measure of profitability) for large Japanese firms were maintained near their highs in the latest quarter, despite rising wages in the overall economy.
Exposure to Japanese equities would be vulnerable if China’s growth were to slow sharply, or if the yen were to increase sharply in value (reducing demand for Japanese exports), but we see these risks as unlikely for now.
Against all odds, Japanese equities remain strongly supported by robust and shareholder-friendly companies and a thriving economy. It’s hard to see what other good news can come along to make foreign investors finally take notice. However, if they did, the upside could be even greater.