After a strong first half, which saw Japanese equities climb to an all-time high in July, the Topix saw a notable sell-off in August, prompted by Japan’s central bank raising interest rates, signalling an end to a period of near-zero costs of borrowing. While the index has since recovered its lost ground, some investors remain tentative.
Whilst there are some grounds for caution, and further short-term movements in the market are possible, Japan remains at a compelling juncture for investors seeking diversification.
A series of transformative trends – spanning corporate governance reforms, digitalisation, generational leadership shifts, and economic modernisation – are reshaping the nation’s business environment.
Combined with structural changes such as re-emerging inflation and a booming tourism sector, these developments present a unique chance to participate in the next chapter of Japan’s economic transformation.
Domestic pressure for corporate governance reforms taking hold
Recent improvements in corporate governance have played a pivotal role in making Japan more attractive to international investors. Whilst corporate governance reform has been a theme of interest internationally for some time, throughout 2024 we have seen a shift in Japan as domestic pressure for reform has intensified.
Companies such as Canon exemplify this trend, driven by increased shareholder activism and regulatory changes. We have also seen a change in attitude from domestic asset managers who, having historically been passive, are now assertively voting their shares, influenced by the stewardship code. This shift is fostering a culture of transparency and accountability, which is crucial for attracting foreign investment.
Similar changes can be seen across smaller companies. They too are embracing governance reforms by appointing independent directors, unwinding cross-shareholdings, and enhancing shareholder return policies. Secom, a security market leader, recently announced a share buyback, reflecting this trend. These changes signal a promising outlook across the breadth of the Japanese market for investors seeking robust corporate governance.
Economic modernisation
Despite being a developed market, Japan remains highly cash-centric, with only about 11% of transactions occurring online. This presents significant opportunities for investment in digitalisation and e-commerce.
Whilst cultural preferences for cash, privacy concerns, and a lack of digital infrastructure contribute to this reliance, initiatives such as the Cashless Rebate Program and partnerships between emerging fintech companies and traditional banks are promoting digital payments.
For example, Mitsubishi UFJ Financial Group has partnered with fintech startup Moneytree to enhance its digital banking services, and Mizuho Financial Group has invested in the blockchain startup LayerX to explore new financial technologies.
Traditional companies are also adapting by introducing digital payment solutions and e-commerce platforms. For example, 7-Eleven has embraced mobile payments, and Mitsukoshi has launched an online shopping platform. These efforts are crucial for staying competitive in a digital age and are playing a key role in the transformation of Japan’s economy.
A generational shift
Japan is currently undergoing a generational shift which is having an acute impact on businesses and the economy. A younger generation of leaders are emerging who are proactively driving modernisation and global integration. These leaders, who are more open to global perspectives, are adopting digital technologies, fostering a culture of innovation, and playing a central role in improving corporate governance.
For instance, Shin Etsu Chemical, a leader in PVC and silicon wafers, has seen a shift in corporate governance with younger board members increasing dividends and buybacks.
In addition to evolving corporate governance practices, a younger generation of leaders is also leading to improved sustainability initiatives and an increased focus on diversity and inclusion. As a result, we are seeing a more blended approach to business which combines traditional Japanese values with modern practices, creating a more balanced business environment.
Re-emergence of inflation
Japan's prolonged battle with deflation is also showing signs of resolution, creating a more favourable economic environment. Higher prices are becoming entrenched, and a labour shortage is driving wage growth, potentially ushering in a new growth cycle. This shift enhances the domestic outlook for companies, making Japan an attractive investment destination.
Continued tourism interest
Tourism has been an important driver of the Japanese economy over recent years and 2024 has seen that trend accelerate. A weak yen has made Japan an affordable destination, drawing tourists with its Michelin-star restaurants, world-class skiing, and rich cultural experiences.
Government initiatives, such as the "Go To Travel" campaign, have further boosted tourism, benefiting local economies, particularly in hospitality, retail, and transportation sectors.
It's undeniable that Japan’s investment landscape is undergoing a renaissance, driven by the culmination of multiple intersecting factors. Whilst such significant transformation is likely to come with a degree of market fluctuation, we expect the regulatory reforms of the past year to continue to drive corporate governance improvements, while the shift to an inflationary environment will drive positive momentum in the Japanese economy.
As these dynamics continue to develop and unfold, the Japanese market has a considerable amount to offer investors.
Nicholas Weindling is portfolio manager of JPMorgan Japanese Investment Trust. The views expressed above should not be taken as investment advice.