Are Japanese equities experiencing a new dawn?
Head of Equity Strategy
Summary: Japanese equities have undergone a renaissance since late 2012 when Abenomics were introduced. Earnings and corporate efficiency have improved dramatically and while the Covid-19 slowdown has temporarily arrested this trend, we believe Japanese companies will come roaring back in 2021 driven by Chinese growth stimulus, a shift towards pro-cyclical and value segments of the market, but also a shift into equity markets with lower financial leverage. Could Japanese equities finally be seeing a new dawn?
Nikkei 225 futures are up 3% today extending November’s gain to 13.9% and this year’s gain of 10.6% as foreign investors are warming up to Japanese equities. That makes Japanese equities one of the best segments of the global equity market is a surprise move because most investors think of Japan as old and dying with irrelevant brands, at least in the age of technology, such as Sony and Toyota. But Japanese equities are signalling something important to investors that should not be ignored. We are guessing that Japan could rise like a phoenix and once again become an equity market that foreign investors want to own.
Abenomics launched in December 2012 started a revival of the Japanese economy lifting inflation, economic growth, and women’s participation in the labour force. The following six years, corporate earnings among publicly listed companies rose 282% or 26% p.a. before a weakening global economy took Japanese earning down by 18% before the Covid-19 pandemic. Earnings are down 54% from the peak but they will come roaring back. Analysts expect earnings to jump 56% over the next 12 months and then 15% more in the following year. These estimates could prove conservative. As we wrote yesterday in our note on emerging markets, China will most likely ease financial conditions in 2021 lifting economic growth in China and Asia benefitting export-driven Japanese companies. But there is more to the Japanese miracle in equities than the usual pro-cyclical factors and Chinese growth.
If we exclude the destruction from the Covid-19 pandemic, Japanese companies have in general lifted their ROE back to the level before the financial crisis in 2008 indicating that Japanese companies are becoming more efficient and shareholder friendly. Several Japanese companies have been under attack by US activist funds forcing them to get rid of crossholdings and inefficient businesses while embracing share buybacks. The current low ROE reflects a crisis and with the rebound in earnings we will also see a rebound in Japanese ROE.
Japanese companies also operate with a much lower net-debt-to-EBITDA (financial leverage), which means that Japanese will do relatively better than US, Chinese and European companies if interest rates or inflation rise in the coming years. Maybe that is what investors are beginning to recognise? On top of that, Japanese companies have very high capital expenditures and R&D level compared to the world paving the path to higher growth in the future. The Japanese equity market also gives exposure to automation and robotics companies which is one of the mega trends in the coming decades. Finally, Japanese equities are trading at a 17% discount to the global equity market on a 12-month basis.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.