Week of June 14, 2013
The tone on investing in Japan has changed. In the six months leading up to May 22, the Tokyo Stock Price Index rose 66% in local currency terms, prompting investors to ask themselves the unthinkable—why have I not allocated more to Japanese equities? During the same time the yen depreciated about 20%, giving Japan’s exporters some much-needed breathing room. However, while the financial markets have given the nod of approval to the economic policies of Prime Minister Shinzo Abe, or “Abenomics,” Japan may possibly be missing a learning opportunity. Times of adversity or crisis can often be the first step on a healthier path and Japan itself is a prime example of this. During the period known as the Meiji restoration, starting in 1868, the country accepted unprecedented social and economic upheaval in order to modernize. Following World War II, Japan and its companies not only rebuilt themselves, they also produced some of the biggest innovations of their day. However, the success arguably also helped foster an industrial base increasingly set in its ways compared to more nimble upstarts from South Korea and Taiwan.
The cozy relationship between politicians, financial institutions and big business, which had underpinned the rapid economic growth leading up to the late 1980s, became an unhealthy crutch. Instead of creating innovation and deploying capital with growing businesses, it sheltered company management teams from making hard, but necessary choices. This resulted in little respect for shareholders and inflexible labor markets that bloated the cost base of Japanese companies. While it may be easy to write off the past two decades due to low growth in Japan and poor equity returns, it would be missing the important changes that have taken place. During the last decade companies in Japan have not been sitting idle, but have begun to implement a more flexible cost base, both in terms of labor as well as off-shoring its manufacturing activities to other lower-cost countries across Asia. Respect for minority shareholders has improved; companies have increasingly committed to shareholder return, predominantly via dividend payments. While these trends are positive, Japan still has further to go. For one, the country has to become less insulated and more open to foreign competition in its domestic markets. While the country’s demographics are fast graying, Japan continues to have just half of its women participate in the workforce. Further improvements on the corporate governance front are also needed.
Abenomics, which involves not just monetary and fiscal policies, but also structural economic reform, is aimed as an all-out attack on the deflationary spiral and general slow economic stagnation experienced in Japan over the past two decades. For the first time since the Bank of Japan’s independence in 1997, the central bank and politicians are working hand-in-hand to address the issue. However, Japan’s malaise is multifaceted and not just resulting from a strong yen that strained the country’s competitiveness or from the deflationary effects of insufficient monetary stimulus. Japan and its companies have previously shown tremendous ability to embrace fundamental change. How they treat the gift of a weaker yen and a reflationary environment will come to dictate business performance for years to come. Will the country continue to become less insular? Will companies better integrate women into the workforce. Will they become more competitive? And will shareholder rights continue to improve? Or will the gift take away the impetus for fundamental change by allowing companies to conduct business as usual, missing the opportunity to learn and move forward? Japan is at a potential crossroad. For the country and investors, I hope they pick the right path.
Jesper Madsen, CFA
The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.