Japan is back. After years of being overlooked, recognition of more profit-driven corporate behaviour is finally gaining deserved attention from global investors. Japanese equities have been cheap versus ‘potential’ for decades. Today, this potential is increasingly being released. The long-standing ‘if only’ bull-story has finally turned into a reality. Luckily, several chapters remain.
Whilst media attention understandably gravitates to what the Bank of Japan (BoJ) is thinking in terms of monetary policy, the fundamental driver of renewed optimism for Japanese equities stems from something a little less headline grabbing: arduous acts of behavioural change and self-help that have been delivered over the course of several years at the individual company level.
Where Japanese companies might have historically put little focus on profitability or shareholder alignment, the past decade has seen significant and deliberate efforts by the corporate sector to improve. Steps to become more effective, efficient and competitive have translated into impressive profit growth in the decade since we first heard about Abenomics.
Zooming back out, recognition of this micro reform has combined with optimism over a structural shift in inflation dynamics to drive the market to its highest level in 33 years.
One stock firmly in the spotlight in 2023 and one which epitomises the change in sentiment is Toyota. The company is having an extremely significant year. Firstly, the presidency passed from Akio Toyoda, grandson of the company’s founder, to former Lexus CEO Koji Sato.
Casual observers of Japan might not see this as a particularly big deal, but we believe it reflects an important and intentional cultural shift. The company is becoming more open than ever before, determined to do whatever it takes to lead the world in mobility solutions.
Secondly, Toyota has used enhanced disclosure concerning its technology stack to shed unfair perceptions that it lags peers on the electrification front. This has been effective. Investors now appreciate that Toyota has world-leading technology in areas like solid state batteries.
Thirdly, the company is in the midst of a sensational earnings year. Whilst the weak yen has helped somewhat, Toyota deserves credit on multiple fronts for the strength of its earnings. The company has managed supply shortages across the industry better than most, allowing undue volume losses to be avoided in what has been a robust demand environment.
Moreover, the company’s strategy to focus on hybrids and plug-in-hybrids as a transition technology along the road to net zero is proving to have been well considered after all. Not only can Toyota boast one of the lowest emission fleets in the world, it also has one of the strongest and most profitable product line-ups in the industry.
Toyota is not alone in Japan in terms of companies that have their swagger back. There are many such examples where intentional improvements in operating models have not only driven growth in profits, but also in self-confidence and a willingness to invest and pursue growth.
The changes we see are not short-term events. These are seismic shifts that have taken multiple years to build up. Results will be yielded for several years to come as positive feedback loops start to unfold.
So what of 2024? No doubt volatility in the yen and interest rate markets will have investors confused and anxious at various points in the year ahead. But don’t let tactics trump strategy. Thanks to transformation of corporate culture since Abenomics came along a decade ago, Japanese companies have delivered impressive earnings growth and a repeat in the decade ahead is a very reasonable base case assumption.
Strong earnings, strong dividend growth and growing buybacks offer the prospect of mid-teen market returns for many years to come… in a cheap currency no less. Patience and a realistic time horizon in Japan offer the prospect of handsome rewards.
Carl Vine, co-head of Asia Pacific equity team at M&G Investments. The views expressed above should not be taken as investment advice.