A person walks in front of an electronic stock board showing Japan's Nikkei 225 index at a securities firm on Sept. 12, in Tokyo.Eugene Hoshiko/The Associated Press
Record highs! Hot growth in a sideways global economy! Is it time to load up on Japan? Yes and no, with myriad nuances. Done rarely and right, Japan is fine. Otherwise, no.
Japan’s TOPIX and Nikkei stock indexes both hit 33-year price peaks in May, with new September TOPIX highs and the Nikkei right on its heels. It all has Japan investor optimism jumping, despite a slight ebbing from early summer giddiness.
Consider: At the start of 2023, analysts’ median forecast saw Japanese stocks rising 13.1 per cent in yen this year. By late August, they upped it to a whopping 29.3-per-cent full-year rise. As I write, Japanese stocks are within two percentage points of that target. More optimism brews. Bank of America’s September global survey reveals fund managers’ net Japanese market allocation hit a 10-per-cent overweight – up from 2022′s year-end 6-per-cent underweight. Partly underpinning the fervour: big headline economic growth. Though revised down from an initial 6-per-cent reading, Japan’s 4.8-per-cent annualized second-quarter GDP growth still crushed the U.S.’s 2.1 per cent and the euro zone’s 0.5 per cent.
But look closer to see the cracks. First, those “record” stock highs stem partly from currency skew. The yen plunged 10.7 per cent this year against the U.S. buck and 11 per cent against the loonie, thanks to Japan’s loony monetary policy. Japanese stocks’ total returns in Canadian dollars are still below 2021′s peaks – and simply in line with the year-to-date rise in world stocks.
Also, Japan’s economy suffers from long-running structural and monetary-policy problems. GDP growth is hugely export-focused. That is okay in general, but currently masks weakness at home. Japanese exports’ 12.9-per-cent annualized second-quarter growth clouds a 2.5-per-cent slide in personal consumption and 16.5-per-cent contraction in imports. Business investment contracted, too.
Slow reform progress is cold comfort. Japan’s conglomerates often trade at discounts globally. Strict labour laws and a sticky web of cross-shareholdings – alliances in which firms own chunks of one another’s shares – have long throttled competition and growth. Bloated, underperforming companies live on, while challengers that might bring efficiencies and progress are stifled. Ultra-low interest rates don’t help, allowing so-called “zombie companies” to survive on dirt-cheap funding. All this explains much of Japan’s legendary economic malaise of the 1990s and 2000s.
New listing rules have firms pledging to boost shareholder value, but plans are slow-moving, widely known and ensure nothing. One August report revealed that just 20 per cent of Tokyo Stock Exchange Prime Market firms have disclosed how they intend to proceed under the new rules. Another 11 per cent were “studying the matter.” Some wrongly assumed the rules didn’t apply to them. Expect more growing pains.
Monetary policy? Since the Bank of Japan pledged “greater flexibility” in guiding government bond yields, the 10-year Japanese yield soared from a paltry 0.45 per cent to, er, a paltry 0.71 per cent. U.S. 10-year Treasury yields rose a smidge more over that stretch. Japan’s enormous quantitative easing efforts smother long bond yields, compressing spreads between short- and long-term yields. It would be great if the Bank of Japan ended its negative rate policy and “yield curve control,” letting long rates float more. But will it? You can’t know. If it doesn’t, the flat yield curve – which waters down bank lending’s profitability – will keep loan growth near August’s tepid 3.1 per cent year-over-year. And, if so, don’t expect booming business investment.
So don’t dive in headfirst. Selectivity is key. First, seek high-quality growth, as growth continues to lead this bull market in Japan and elsewhere. Then, focus heavily on exporters, which depend less on Japanese demand. Key in on Big Tech, especially semi-conductors and semi-conductor equipment firms. Their fat, 46-per-cent gross margins fuel reinvestment and continuing growth.
But tech is just 13.5 per cent of Japan’s market capitalization, and semi-conductors are just 4.2 per cent. The United States, the Netherlands, Taiwan and South Korea all have bigger tech tilts. And like Canada, Japan has next to no exposure in the tech-like interactive media and services and broadline retail industries – two growth hotbeds within the communication services and consumer discretionary sectors, respectively. Also largely lacking: luxury goods, the high-growth industry I detailed in June.
Japan’s market instead leans toward economically sensitive value stocks, which are out of favour in this bull market, given sluggish global growth. Automobiles and auto components comprise 10.9 per cent of Japan’s market cap, almost quadrupling the world’s weight. Industrials are 23.1 per cent, versus the world’s 10.8 per cent. Gross profit margins in both are sub-20 per cent. Financials – with their growth-sapping lending spreads – are another 12.5 per cent.
Let Wall Street cheerlead Japan’s meagre reforms and backward-looking, hollow data. Own some for diversification. But hype and heat are bad reasons to invest heavily anywhere.
Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments.
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