Japan’s new prime minister – seen as the status quo candidate when he succeeded his party colleague Yoshihide Suga recently – is to contest a general election this weekend. As a result, there was little early prospect of the kind of structural reforms that would excite markets, David Whitehouse reports.
However, fund managers do not see Japanese stocks as expensive and point to growth potential in export-related areas such as automation.
In the wake of Suga’s resignation, the Japanese parliament chose former foreign minister Fumio Kishida at the end of September. The election was called for October 31.
Zuhair Khan, managing director at Union Bancaire Privée (UBP) in Tokyo, says Kishida is “clearly not the public’s preferred choice” and “the markets are not very keen”. Some are disappointed that the younger, more reform-minded Taro Kono didn’t get the job.
“From a market perspective, people would have preferred Kono as the clear reform candidate,” Khan says. The elections mean that for now, Kishida will do no more than “tell people what they want to hear”. The vote will be followed by upper house elections next summer. “He has to do well in these two hurdles or his days will be numbered,” Khan says.
Even if Kishida does well electorally, Khan sees little sign that he will introduce radical reforms. Kishida attended the Kaisei Academy, a school noted for producing the core of the country’s bureaucracy, so there are concerns that he is a bureaucrat at heart, Khan says. There is “not much to indicate that he will be a reformist”.
Only a modest amount of real structural reform took place during the eight-year administration of Shinzo Abe that ended in 2020, Khan says. “Structural reform needs to be reinvigorated” but there is little sign that Kishida will provide the momentum. He achieved power due to the support of Liberal Democratic Party (LDP) grandees and needs to win elections to obtain the personal power that would enable him to introduce his own agenda, according to Khan.
The LDP is unlikely to hold all of its existing seats in the elections and the question is how many seats the party will lose, says Hideki Shigenobu, CEO at Canreki Capital in New York. He puts the chances of serious losses at more than 50%. Loss of a lower house majority, which is a “decent possibility”, would leave Kishida’s survival in question, he adds.
In his first major policy speech on October 8, Kishida said that he would redistribute wealth, reduce inequality and implement a “new form of Japanese capitalism”. The reality, though, is that he is “a typical LDP politician” who is “not very policy-driven,” says Shigenobu, who was a fund manager at the Teachers Insurance and Annuity Association of America (TIAA) for 19 years.
Kishida’s own LDP faction is not big enough to deliver power, so the new prime minister will continue to need broad consensual support from other factions, Shigenobu says. That means radical reforms are unlikely. There is “no meat on the fancy words. The LDP wants business as usual. They don’t want radical change.”
Reopening prospects
The new prime minister is a “politicians’ politician” who is “much more popular amongst his peers than he is with party members or the electorate at large”, says Japan specialist Daniel Carter, a fund manager at Jupiter Asset Management in London. In the general election, the LDP may win by a smaller majority than would have been the case had Kono become prime minister, he says.
Kishida has emphasised the importance of fiscal support to bolster the domestic economy. Carter argues that usually, the impact of such packages is “enormously” overstated.
“The pump-priming, high-multiplier argument for expansionary fiscal policy holds little water in Japan where such spending is usually sterilised early,” he says.
Still, Carter adds, prospects for recovery will largely be determined by domestic and international factors outside of the prime minister’s control. He cautions against over-emphasising the likely impact of specific political personnel on the market, and says: “Japan’s pandemic recovery should determine the direction of travel, with policies perhaps just boosting the speed.”
Japan in early October, says Khan, had already overtaken the US in terms of vaccinations and was poised to overtake Europe in the coming month, with more than 1% of the population being vaccinated every day. While people opposed to vaccines have slowed progress in the West beyond a certain threshold, Khan sees little signs of significant resistance in Japan’s conformist, group-centred culture. “The anti-vaxxers have largely vanished.”
“Massive” savings have built up in Japan since the start of the pandemic, Khan says. The economy will speed up when pandemic restrictions on travel are finally eased, and anything related to consumption will benefit. Khan says that the government has been “excessively cautious” on travel and expects that international travel restrictions will be lifted by the end of the year. “In the short term there is good news for the market, but a question mark and disappointment over long-term reform.”
Bubble warning
Veteran investor Atsuto Sawakami, creator of Japan’s first low-cost mutual fund, took out full-page advertisements in his country’s newspapers in September to warn that zero interest rates and monetary easing were pushing the stock market into “bubble” territory. “Get as far away as possible from this growing, epic bubble,” Sawakami wrote. “The time to act is now.”
According to Yardeni Research, the forward price-to-earnings (PE) ratio for the Japan MSCI index stands at 14.6, higher than China on 12.6 and emerging Asia on 13.5. But there is by no means a consensus that the equity market is overvalued. The volatility of PE ratios during the pandemic means that Khan is using price-to-book as his preferred value measure. The Topix 2000 and 500 indexes in early October were both trading at around 1.3 times book value, which Khan sees as “very reasonable”, with a number of mid and large caps trading below book value.
Esty Dwek, chief investment officer at Flowbank in Geneva, believes that “the bounce in Japanese equities that started with Suga’s resignation can persist as vaccination rates continue to improve and global growth recovers”. She says the market will be lifted by the “relative attractiveness of Japanese valuations and expected recovery in earnings”.
Automation
The country is emerging from three decades of deflation and heading for a period of low inflation in the region of 1% to 1.5%, Shigenobu says. The population is declining and productivity is stagnant. Japan’s Tankan business confidence survey improved only slightly in September to -2, versus -3 in June, though there was a positive contribution from software and R&D investments. Investors need to distinguish between Japanese companies and the overall market, Shigenobu says.
The population has declined every year since 2010. Over the medium term, growth in Japanese consumption has been “extremely muted”, Carter says. “This is a function of Japan’s ageing population – an issue which is not going away” and which Jupiter bears in mind when considering Japanese consumer-related stocks, he says.
Export volumes from Japan posted double-digit growth in both July and August, with the rebound in machinery exports leading the way. Japan has strengths in robotics and industrial automation built on its long-term technological leadership in manufacturing. Companies with strong export prospects, says Shigenobu, include robot-maker Fanuc; Keyence, which manufactures automatic control equipment; Murata Manufacturing, which supplies smartphone companies such as Apple; and the sensor company Omron.
These companies have shown themselves able to weather the pandemic. Fanuc, which has a global market share of about 18%, said at the end of July that its factories were operating at an “extremely high” level of production, underpinned by strong demand from China, the Americas and Europe. Keyence, which ranks as Japan’s top-paying employer, was added to the Nikkei 225 index along with Murata at the start of October.
Analysts welcomed the changes to the Nikkei as a step towards an index that is more representative of Japan’s economy. According to Hennessy Advisors, global demand for industrial robots is growing at 46% a year, and the global robotics market is estimated to reach $248.5 billion by 2025. Japan is well positioned to address Asia, the largest end-market for factory automation. Asia accounted for nearly 70% of the purchases of industrial robots in 2019, well ahead of China at 21%.
All this means that a sector-based approach may work better than buying Japan Inc. “You don’t want to buy domestic companies where the market is about to shrink,” Shigenobu says. “Japan is good at automation, but I wouldn’t buy the market.”
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