Japan's Market Rally

[윤영준]

The benchmark Nikkei 225 and Topix indices achieved their highest levels in more than 30 years as foreign investors poured into Japanese equities in volumes never seen in at least a decade. In the US, the average bear market historically lasts about 14 months, and stocks return to their previous highs three to five years later. On the contrary, Japan has waited three decades for its key stock market indices to revisit their record high of December 1989.

A wave of interest in the country’s stocks, which have risen by 23% so far this year, can propel the market further. Some gains may be temporary. The key driver of the rally in local currency terms has been the weakness in the yen, which has fallen by 7% against the US dollar since the beginning of the year. Investor sentiment rallied as the dollar strengthened because the value of profits made overseas receives a boost when booked at home. However, the yen is expected to reverse course before long as the Fed is getting closer to its target rates. In fact, removing the currency effect erases the outperformance of Japanese equities over their US counterparts this year.

Optimism about corporate-governance reforms have provided another boost. After what turned out to be a false dawn a decade ago, when “Abenomics” first raised hopes of corporate governance reform in Japan, many seem to think better of the latest measures by the Tokyo Stock Exchange. The Tokyo Exchange Group recently finalized its market restructuring rules. Among the latest measures was one that directed listed companies to comply or explain if they are trading below a price-to-book ratio of one – an indication that a company may not be using its capital efficiently. The Tokyo Stock Exchange warned that such companies could face the prospect of delisting as soon as 2026. Part of the optimism in Japanese stocks stems from how specific and tangible the Tokyo Stock Exchange’s requirements are this time round. Even Warren Buffet endorsed his enthusiasm by raising his stakes in Japan’s top 5 trading houses.

There is hope this would press Japanese companies’ stubbornly resistant management for greater capital efficiency and profitability. The scale for change is tremendous as the Tokyo Stock Exchange said in March that half the number of its prime listings – the most liquid stocks with the largest market capitalization – and about 60% of those in the standard listings have a return on equity of less than 8% and are trading at price-to-book ratio of less than one. The Tokyo bourse operator wants to ensure companies gain sustainable growth and increase corporate value over the mid- and long-term by focusing on the cost of capital and profitability based on the balance sheet rather than just sales and profit levels on the income statement. Namely, they want to see real strategic changes made in tandem with shareholders. This is a radical turnaround given that Japanese companies’ managements typically view shareholders as enemies.

Known as Abenomics introduced after the general election in 2012, the much-touted economic policy was aimed at reviving economic growth and combating the chronic deflation that has plagued the world’s third-largest economy since the 1990s. Corporate governance is the third arrow of the three core tenets of Abenomics – monetary easing and fiscal stimulus are the other two. While the initial euphoria in Japanese stock markets over Abenomics was short-lived back in the early 2010s, investors now see a potential for a fundamental re-rating of Japanese equities should these latest corporate governance reforms take hold. This time investing in Japanese equities is not investing in Japan’s macroeconomic growth, but it is investing in more of a profit growth opportunity coming from margin improvement and return on equity improvement. In particular, uncomfortably high recession risk in the US and Europe plus China’s languishing stock market make Japanese stocks look relatively more attractive.

But a bigger factor in the long term is whether they will retain the focus on profitability by cutting underperforming business units and restructuring. The attitude change towards shareholders will take time to play out in Japan. These are more difficult decisions to undertake, but would ultimately be the real gauge of corporate Japan’s appetite for reform, greater efficiency, and productivity. The improved profitability and returns that result from shareholder-friendly governance can help the Japanese stock market. Yet solid economic growth is practically precondition for sustaining a prolonged rally. Since 1990, the Japanese economy has significantly lagged behind other G7 countries with the exception of Italy. Consequently, corporate earnings of Topix only managed to treble its level in 1990 whereas S&P500 companies’ earnings have grown almost ten times over the same period. We remain sceptical that the recent strong gains in Japan’s equity market mark the start of a significant reversal of its decades-long underperformance. There are still a lot of catch-up in corporate earnings compared to the US, and Japan still lacks IT-oriented power houses. One bright spot is its attractive valuation, which will help Japan’s equities do a little better than those in the US in the long term. In addition, lower inflation and easier monetary policy could deliver slightly better returns than other developed markets.

[좋은세상]

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